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2017 STAFF GUIDANCE NOTE ON THE FUND'S ENGAGEMENT WITH SMALL DEVELOPING STATES

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January 2018

http://www.imf.org/external/pp/ppindex.aspx

2017 STAFF GUIDANCE NOTE ON THE FUND'S

ENGAGEMENT WITH SMALL DEVELOPING STATES

EXECUTIVE SUMMARY

This guidance note highlights the unique economic characteristics and constraints facing

small developing states. It provides operational guidance on Fund engagement with such

countries, including on how small state characteristics might shape Fund surveillance and

financial support, program design, capacity building activities, and collaboration with

other institutions and donors.

The note updates the previous version that was published in May 2014. It incorporates

modifications resulting from Board papers and related Executive Board discussions that

have taken place since the March 2013 Board papers on small states, which provided the

foundations of the original guidance note.

Based on these inputs, five key thematic areas (G.R.O.W.TH.) have been identified as

central to the policy dialogue:

• Growth and job creation. With small states experiencing relatively weak growth

since the 1990s, Fund staff working on small states should ensure an explicit focus on

growth in both surveillance and program-related work.

• Resilience to shocks. Small states experience higher macroeconomic volatility and

more frequent natural disasters. Staff should be ready to advise on how to tailor

macroeconomic policies to provide greater resilience to shocks and climate change.

• Overall competitiveness. Options to improve relative prices may include exchange

rate adjustment (where possible) or measures supportive of internal devaluation (if

not), and efforts to improve the business climate, including through regional

initiatives.

• Workable fiscal and debt sustainability options. With many small states having

very high debt burdens, reducing debt to manageable levels requires sustained fiscal

consolidation with supporting policies and structural reforms. In cases where the

amount of adjustment needed to restore debt sustainability is not feasible or

adequate financing is not available, debt restructuring may be needed.

• Thin financial sectors. Developing deeper and more competitive, yet sound,

financial sectors contributes to macroeconomic stability and enhances the

effectiveness of policy interventions while strengthening competitiveness by

improving business access to financial services.

In applying this guidance, staff should continue to tailor their engagement to specific

country circumstances.

December 11, 2017

STAFF GUIDANCE NOTE ON THE FUND’S ENGAGEMENT WITH SMALL DEVELOPING STATES

2 INTERNATIONAL MONETARY FUND

Approved By Seán Nolan

This update of the guidance note was prepared by Mai Farid and Ermal

Hitaj, under a project supervised by Peter Allum and Xavier Maret (all SPR)

and in close collaboration with other Fund departments (AFR, APD, EUR,

FAD, LEG, MCD, MCM, and WHD). Research assistance was provided by

Corinne Stephenson and Yining Zhang, and production assistance by

Merceditas San Pedro-Pribram (all SPR).

CONTENTS

Abbreviations and Acronyms _____________________________________________________________________ 4

INTRODUCTION _________________________________________________________________________________ 6

DISTINCTIVE CHARACTERISTICS AND VULNERABILITIES OF SMALL STATES _______________ 10

PRIORITIES FOR POLICY DIALOGUE ___________________________________________________________ 15

A. Growth and Job Creation _____________________________________________________________________ 15

B. Resilience to Shocks __________________________________________________________________________ 18

C. Overall Competitiveness ______________________________________________________________________ 20

D. Workable Fiscal and Debt Sustainability Options _____________________________________________ 22

E. Thin Financial Sectors _________________________________________________________________________ 24

SURVEILLANCE AND ANALYTICAL WORK ____________________________________________________ 25

PROGRAM DESIGN, AND FUND FACILITIES AND INSTRUMENTS ___________________________ 30

CAPACITY DEVELOPMENT _____________________________________________________________________ 35

COORDINATION WITH DEVELOPMENT PARTNERS __________________________________________ 36

BOXES

1. UN and World Bank Groupings of Small States ________________________________________________ 6

2. Sub-Groupings of Small States _________________________________________________________________ 9

3. Regional Characteristics of Small States _______________________________________________________ 14

4. Explicit Growth Focus in Small States__________________________________________________________ 17

5. Analytical Issues in Small States _______________________________________________________________ 26

6. Integrating Natural Disasters and Climate Change into IMF Macro-Frameworks and Risk Analysis

__________________________________________________________________________________________________ 28

7. Pilots on Climate Change _____________________________________________________________________ 29


INTERNATIONAL MONETARY FUND 3

TABLES

1. Selected Indicators of Small States ____________________________________________________________ 10

2. Fund TA to Small States, FY2015–16 __________________________________________________________ 35

ANNEX TABLES

1. List of Small and Micro Developing States ____________________________________________________ 38

2. United Nations and World Bank: Groupings of Small Developing States ______________________ 39

3. List of Small States with Staff-Monitored Programs ___________________________________________ 40

4. Fund Emergency Assistance in Small States ___________________________________________________ 41

5. Fund Financing Arrangements for Small States _______________________________________________ 42

6. Selected Recent Examples of Sovereign Debt Restructurings in Small States __________________ 43

APPENDIX BOXES

1. Monetary Policy in Small States _______________________________________________________________ 44

2. Fiscal Rules for Small States ___________________________________________________________________ 45

3. The Caribbean Catastrophe Risk Insurance Facility (CCRIF) ____________________________________ 47

4. Risk Financing Toolkit _________________________________________________________________________ 48

5. Devaluations in Small States: How Effective? __________________________________________________ 50

References _______________________________________________________________________________________ 51



Abbreviations and Acronyms

AFRITAC African Regional Technical Assistance Center

AML/CFT Anti-Money Laundering/Combating the Financing of Terrorism

BoP Balance of Payments

CARTAC Caribbean Regional Technical Assistance Center

CBR Correspondent Banking Relationships

CCPA Climate Change Policy Assessment

CD Capacity Development

CS Commonwealth Secretariat

CLICO Colonial Life Insurance Company

CPIA Country Policy and Institutional Assessment

DSA Debt Sustainability Analysis

DSF Debt Sustainability Framework

ECCU Eastern Caribbean Currency Union

ECF Extended Credit Facility

EDD Economic Development Document

EMs Emerging Markets

ENDA Emergency Natural Disaster Assistance

EPCA Emergency Post-Conflict Assistance

ESF Exogenous Shocks Facility

FAD Fiscal Affairs Department

FSAP Financial Sector Assessment Program

GDP Gross Domestic Product

GNI Gross National Income

GRA General Resources Account

HIPC/MDRI Heavily Indebted Poor Countries/Multilateral Debt Relief Initiative

IBRD International Bank for Reconstruction and Development

IDA International Development Association

IFIs International Financial Institutions

IMF International Monetary Fund

LICs Low-Income Countries

MDBs Multilateral Development Banks

MEFP Memorandum of Economic and Financial Policies

NPL Non-Performing Loan

ODA Official Development Assistance

OFCs Off-Shore Financial Centers

PCI Policy Coordination Instrument

PEFAs Public Expenditure and Financial Accountability

PICs Pacific Island Countries

PFM Public Finance Management

PFTAC Pacific Financial Technical Assistance Center



PPPs Public Private Partnerships

PSI Policy Support Instrument

PRGT Poverty Reduction and Growth Trust

PRS Poverty Reduction Strategy

RTAC Regional Technical Assistance Center

REO Regional Economic Outlook

RCF Rapid Credit Facility

RFI Rapid Financing Instrument

RGSM East Caribbean Regional Governments Securities Market

ROSC Report of the Observance of Standards and Codes

SBA Standby Arrangement

SMP Staff-Monitored Program

SSF Small States Forum

TA Technical Assistance

UN United Nations

UN-OHRLLS UN Office of the High Representative for the Least Developed Countries, Landlocked

Developing Countries and Small Island Developing States

UCT Upper Credit Tranche

WB World Bank

WEO World Economic Outlook



INTRODUCTION

1. This guidance note focuses on small developing countries with populations of under

1.5 million. The Fund has 43 members with populations of fewer than 1.5 million, of which 34 are

small developing countries (hereafter “small states,” Annex Table I).1 The guidance note also

considers the special macroeconomic challenges faced by “micro” states, with populations of fewer

than 200,000. In practice, many countries with populations larger than 1.5 million have

characteristics of “smallness,” and this guidance note is relevant, in varying degrees, to these

countries as well. The United Nations (UN) and the World Bank (WB) use slightly different groupings

of small states, as presented in Box 1.

Box 1. UN and World Bank Groupings of Small States

• The UN’s Small Island Developing States (SIDS) grouping includes 38 UN member states, all of which

participate in the Alliance of Small Island States (AOSIS), an ad hoc negotiating body established by

SIDS at the UN. The SIDS grouping contains a diverse set of countries, which vary markedly in terms

of land area, geographic location, and income levels (from low income to upper middle income

status). 1/

• The WB makes use of a small states grouping that includes 50 countries: these countries have a

population of 1.5 million or less, or are members of the Small States Forum, a high-level meeting of

policy-makers hosted by the World Bank during the IMF-WB Annual Meetings. 2/

• See Annex Table 2 for a listing of the UN SIDS and WB Small States groupings

___________________________

1/ See UN-OHRLLS.

2/ See World Bank Group Engagement with Small States: Taking Stock (WB, 2016)

2. The note provides operational guidance to staff on the Fund’s engagement with small

states. It updates the previous 2014 note, which reflected the March 2013 Executive Board

discussion of small states and the associated background papers.2 To this effect, it incorporates

modifications from relevant Board papers and decisions since that time, including:

• the May 2015 Board paper on “Macroeconomic Developments and Selected Issues in Small

Developing States” (IMF, 2015a), which focuses on fiscal frameworks, external devaluation, and

financial inclusion in small states;

1 The small developing states grouping excludes small states defined as advanced market economies for World

Economic Outlook (WEO) purposes, and fuel-exporting countries classified by the World Bank as “high income”

(Bahrain, Brunei Darussalam, and Equatorial Guinea).

2 “Macroeconomic Issues in Small States and Implications for Fund Engagement” (IMF, 2013a); “Asia and Pacific Small

States—Raising Potential Growth and Enhancing Resilience to Shocks” (IMF, 2013c); “Caribbean Small States—

Challenges of High Debt and Low Growth” (IMF, 2013d); and the associated summing up “The Acting Chair’s

Summing Up-Macroeconomic Issues in Small States and Implications for Fund Engagement” (IMF, 2013b).

http://unohrlls.org/about-sids/

http://www.imf.org/external/np/pp/eng/2015/030915.pdf



http://www.imf.org/external/np/pp/eng/2013/022013a.pdf


http://www.imf.org/external/np/pp/eng/2013/022013b.pdf


http://www.imf.org/external/np/sec/pn/2013/pn1339.htm

http://www.imf.org/external/np/sec/pn/2013/pn1339.htm



• the December 2016 Board paper on “Small States’ Resilience to Natural Disasters and Climate

Change—Role for the IMF” (IMF, 2016a) which discusses climate vulnerabilities and elaborates on

policies to address such challenges through risk reduction, mitigation and adaptation measures,

disaster preparedness and response, and financing options; and

• the May 2017 Board paper on “Large Natural Disasters—Enhancing the Financial Safety Net for

Developing Countries” (IMF, 2017a), which led to Board approval of a new annual access limit of

60 percent of quota under the Rapid Credit Facility (RCF) and the Rapid Financing Instrument

(RFI) for members experiencing urgent balance of payments needs arising from severe natural

disaster-related damages.

3. The Fund has recognized, in various policies and fora, the special characteristics and

challenges of small states. Small size is one of the elements of the Poverty Reduction and Growth

Trust (PRGT) eligibility framework.3 Fund staff share analytical perspectives through a “Small Islands

Club,” cross-country analytical studies, and regional conferences that regularly address the needs of

small states. Regional technical assistance centers (RTAC) in the Caribbean and the Pacific focus

primarily on the capacity building needs of small states.

4. Fund policies and engagement cannot be informed by country size alone. “Smallness” is

one important factor that should influence Fund policy analysis and advice. Small states are very

heterogeneous (Box 2). Some have achieved considerable economic success while others are among

the poorest in the world and in fragile situations. Staff should focus on the particular economic

needs of each country, rather than adopting a standardized approach.

5. This note focuses on what is distinctive about small developing economies. For

instance, although small states are often poor, poverty is not an issue of scale and is not addressed

here in detail. The note is intended to be a primer for staff new to small states issues, but should be

of value also to experienced country teams, by providing a consolidated overview of such issues.

6. The disproportionate vulnerability of small states to natural disasters and climate

change has important economic implications for small states. This vulnerability contributes to

lower investment levels, lower per capita income levels, higher poverty and a more volatile revenue

base. This note incorporates the main findings of the 2016 Board paper on small states’ resilience to

natural disasters and climate change (IMF, 2016a), which examined how domestic policies can

reduce the direct human and economic costs of climate change and natural disasters.4

7. The guidance note is organized as follows: the first section discusses distinctive

characteristics and vulnerabilities of small states; the second section covers priorities for policy

dialogue and engagement of Fund teams with small states; the specific aspects of Fund activities

3 The World Bank’s IDA also includes a small island economy exception linked to countries with populations under

1.5 million. The same population cutoff was used to define small states in the influential 1998 Joint Task Force Report

on Small States of the Commonwealth Secretariat and World Bank.

4 See also “Enhancing Resilience to Natural Disasters in Sub-Saharan Africa,” (IMF, 2016f).

https://www.imf.org/external/np/pp/eng/2016/110416.pdf


http://www.imf.org/~/media/Files/Publications/PP/pp051517-large-natural-disasters.ashx


https://www.imf.org/~/media/Websites/IMF/imported.../_chapter31016pdf.ashx



that are most relevant to small states in the areas of surveillance, program design, financial

assistance, and capacity development are presented in sections three to five; the final section

reviews coordination with other institutions and donors. The appendices present analytical work on

selected topics of relevance to small states, including fiscal rules and monetary and exchange rate

policy.5

5 The internal Knowledge Exchange site on small states provides additional analytical work, country cases, and

database available to country teams. The 2014 guidance note provided country examples illustrating good practices

(IMF, 2014a); These are now available on the Knowledge Exchange site.

http://intranetapps.imf.org/fundwide/KE/Topics/Small-States/Pages/Home.aspx





Box 2. Sub-Groupings of Small States

The set of small states can usefully be divided into several sub-groupings:

• Tourism based countries are those where exports of tourism services exceed 15 percent of GDP and

25 percent of total exports. Approximately half of the small states are tourism based, rising to three-quarters

in the Caribbean region.

• Commodity exporters are those countries where at least 20 percent of total exports in 2008–2012 were

natural resources. Twenty percent of small states are in this group, which includes two fuel exporters

(Trinidad and Tobago; Timor-Leste) and other diverse commodity exporters: Guyana (gold); Belize (citrus,

sugar, and bananas); Suriname (alumina, gold, and oil); Solomon Islands (logs and minerals); and Bhutan

(hydroelectricity and steel). Trinidad and Tobago is the only commodity exporter that falls in the high-

income group.

• Small states in fragile situations are defined as having weak institutional capacity as measured by the

World Bank Country Policy and Institutional Assessment (CPIA) score (three-year average of the CPIA score

below 3.2 or lower) and/or experience of conflict (signaled by presence of a peace-keeping or peace-

building operation in the most recent three-year period (IMF, 2015d). Nearly one-third of small states are in

a fragile situation; all except three (Comoros, Djibouti, and São Tomé and Príncipe) are in the Asia-Pacific

region.

• Micro states are defined as having populations below 200,000. Almost half of all small states are micro

states combined, they account for about 10 percent of the total population of all small states. All microstates

are islands.

• Two countries do not fall into the above analytical groupings—Montenegro and Swaziland.

Micro States Palau

Tonga

Nauru

Comoros

Djibouti

Fragile States

Kiribati

Marshall Islands

Micronesia

Tuvalu

São Tomé and

Príncipe

Bhutan

Guyana

Trinidad and Tobago

Suriname

Commodity Exporters

Solomon Islands

Timor-Leste

Bahamas

Barbados

Cabo Verde

Fiji

Mauritius

Vanuatu

Tourism Based

Belize

Antigua and Barbuda

Dominica

Grenada

Samoa

Seychelles

St. Kitts and Nevis

St. Lucia

St. Vincent and Grenadines

Others Montenegro

Swaziland

Small States Caribbean

Asia-Pacific

Africa

Europe

Caribbean countries are in blue; Asia-Pacific countries are in red; African countries are in black; European countries are in green.

Maldives



DISTINCTIVE CHARACTERISTICS AND

VULNERABILITIES OF SMALL STATES

This section reviews characteristics of small states that affect macroeconomic policy design and

recommendations, such as a narrow economic base, high levels of openness, shallow financial

systems, exchange rate regime rigidities, and weaker institutional capacity. These features can

contribute to high vulnerability to shocks, subdued growth performance, and unsustainable

debt dynamics.

8. Small states do not enjoy the benefits of economies of scale. Technologies for producing

goods and services are commonly subject to indivisible fixed costs. In the case of tradable goods,

these costs represent powerful barriers to entry in small states, causing these countries to rely more

on imports than on domestic-production. This results in high trade openness and high exposure to

terms-of-trade shocks and volatile trade tax revenues (Table 1). With a narrow economic base and

small market size, there is often limited scope to use specialized expertise, which is a factor behind

high rates of outward migration (or “brain drain”) among the more highly educated.

Table 1. Selected Indicators of Small States

9. Scale economies hamper the provision of public goods and services. Small states do not

have populations large enough to support a full range of public goods and services, despite high

levels of public spending in relation to GDP. Where key public infrastructure is under-provided

Country Groups / Indicators Micro Other SSOther LIC

and EM

GDP Per Capita Growth (annual, percent) 1.5 2.0 2.7

GDP Per Capita (current U.S. Dollars) 4707 3520 1880

Trade Openness 98 103 71

Government Expenditure 34 30 26

Government Debt 57 48 40

Net ODA Received 1 9.7 4.0 2.7

GDP growth 3.2 2.1 2.2

Current Account Balance to GDP ratio 5.0 4.0 2.9

Fiscal Balance to GDP ratio 2.7 2.2 1.8

Aid to GNI ratio 1 2.7 1.4 0.7

Private Credit to GDP ratio 3 3.3 3.9 2.6

Sources: World Economic Outlook database; World Development Indicator database; Ccountry authorities;

and IMF staff estimates.1 Median of 2000-2014 due to data availability. Data source: World Bank WDI database and staff calculation.

2 Volatility is measured as a five-year backward-looking standard deviation of a variable. For example, the

volatility reported for the year 2000 is the standard deviation of a variable x from year 1996 to 2000.3 Domestic credit to private sector (% of GDP). Median of 2000-2015 due to data availability. Data source:

World Band WDI database and staff calculation.

2000-2016, median

(Percent of GDP)

Volatility Measures 2



(ports, power, roads, etc.), this can adversely impact competitiveness. With public policy agencies

that are limited in absolute size, capacity to design and implement policies can also be a challenge.

10. Because of narrow production and export bases, small states have greater

vulnerability to external shocks and experience more macroeconomic volatility than larger

peers. This is particularly evident with regard to the growth and external performance of micro

states. Volatility comes from narrow production and export bases, which leave small states

macroeconomically vulnerable to industry-specific shocks.

11. Despite their minimal contribution to global warming, low-income countries (LICs)

and small states are often the hardest hit by natural disasters and the most vulnerable to

climate change.6 One-third of small states are highly or extremely vulnerable to climate change in

the lifetime of the current generation partly because it can exacerbate natural disasters and partly

because of more gradual effects such as rising sea level and pressures on the ecosystems.7 In

addition, many small states are disproportionately vulnerable to natural disasters (such as

earthquakes and hurricanes) compared to larger peers both because of their location and because

they do not have the geographic scale to provide diversification against location-specific shocks.8

The ability of small states to manage such shocks is typically hampered by limited fiscal space, weak

fiscal frameworks, shallow financial systems (which give less scope to rely on domestic financing to

weather shocks), and thin administrative capacity (which complicates disaster mitigation and

recovery efforts).

12. Staff analysis of small states needs to pay special attention to the distinction between

domestic value-added (GDP) and income accruing to nationals (Gross National Income, or

GNI). Small states typically have high levels of foreign ownership in many sectors of the economy;

typical examples include banking, hotels, and resource extraction. As a result, policies that boost

GDP via the expansion of predominantly foreign-owned sectors of the economy need not translate

into an increase in GNI (which captures the welfare of nationals).9 Careful attention needs to be

given to assessing income distribution effects in evaluating national policies.

6 See “Small States’ Resilience to Natural Disasters and Climate Change—Role for the IMF”, (IMF, 2016a).

7 Many indicators to assess the vulnerability of small states have been developed, such as the Commonwealth

Vulnerability Index. The World Bank has initiated in 2016 a project to operationalize metrics of vulnerability that

could complement existing income benchmarks for eligibility to concessional financing. Other indicators include

Maplecroft climate change vulnerability index, and Notre Dame (ND-Gain) vulnerability and readiness index.

8 The Fund developed in 2011 an analytical tool for vulnerability assessment in low- and middle-income countries,

which provides an assessment of underlying risks to a severe growth recession in the event of exogenous shocks,

including natural disasters, summarized in a growth decline vulnerability index (Dabla-Norris and Bal Gunduz, 2012).

9 As an example, consider a case where all hotels are foreign-owned, the primary input purchased locally is semi-

skilled labor, and the sector benefits from significant tax holidays: in such a case, a fall in wage levels, while it may

promote additional investment in the hotel sector, could easily leave nationals worse off (unless the elasticity of

employment to wage cuts is very high).

http://www.imf.org/~/media/Websites/IMF/imported-full-text-pdf/external/np/pp/eng/2016/_110416.ashx

https://maplecroft.com/about/news/ccvi.html

http://index.gain.org/



13. Strengthened growth performance is a priority for small states. Per capita income levels

and social indicators of small states are currently broadly in line with those of larger developing

country peers, on average.10 But since the late-1990s, the average growth rate for small states has

slowed, even as that for larger developing countries has accelerated with commensurate gains in

social indicators. Microstates have, unsurprisingly, also experienced higher levels of volatility than

larger countries.

14. High public debt burdens threaten sustainability, notably in the Caribbean which

includes some of the world’s most highly indebted countries (measured by debt-GDP ratios).

The Caribbean debt problems can be traced to the cost of natural disasters, fiscal management

gaps, loss-making public enterprises, and sub-par economic growth.11 Because of the middle-

income status of many Caribbean countries, they have not been eligible for debt relief under the

Heavily Indebted Poor Countries/Multilateral Debt Relief Initiatives (HIPC/MDRI)—although some

have benefitted from other forms of debt relief, including through the Paris Club. While debt levels

for the small Pacific Island Countries (PICs) are generally modest, rising levels of indebtedness in

some countries are a cause for concern.

15. Financial systems in small states are typically shallow, concentrated, and foreign-

dominated. The economic base in small states is rarely enough to support multiple financial

institutions, and lending opportunities for banks are thin.12 Banks in small states tend to lend

disproportionately to the government, linking financial sector soundness closely to fiscal

sustainability; and residents of small states, particularly in the Caribbean, often rely on nonbank

financial institutions. Both banks and nonbank financial institutions frequently suffer from high non-

performing loans (NPLs) and low-asset quality (Caribbean credit unions are a case in point), partly

because of weak institutions for financial supervision and regulation. Financial system vulnerability

poses risks, in turn, for budgets (through potential bailout costs). Regulatory capacity is also an issue

for cross-border financial flows, with implications for risks of financial contagion and spillovers to

other countries.13 It includes the capacity constraints to properly implement relevant international

standards, including for Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT)

and tax transparency purposes, exposing small states to reputational risks particularly if they engage

in higher risk activities (e.g., offshore sectors, citizenship by investment). Small states are also poorly

served by global capital markets. International investors can be reluctant to take on small states

exposure, given the risks posed by economic volatility and the disproportionate costs of

10 Larger peers are defined as countries with a population over 1.5 million, excluding advanced economies.

11 See specific country case studies on Guyana and St. Kitts and Nevis in Appendix Boxes 7 and 8 of the 2014

Guidance Note (also available at the internal Knowledge Exchange site on small states).

12 In some cases, this occurs notwithstanding the existence of large off-shore financial centers (OFCs) serving non-

resident markets.

13 For instance, the failure of Colonial Life Financial and its life insurance subsidiary, Colonial Life Insurance Company

(CLICO), and the failure of the Stanford Financial Group had cross-border implications in the Caribbean.




administering and monitoring relatively small financial transactions. This can result in illiquid

markets for debt in small states.

16. Pegged or heavily managed exchange rates are typical for small states.14 Fixed

exchange rates provide a nominal anchor when options for an independent monetary policy are

limited by administrative capacity or by weak monetary transmission mechanisms in shallow

financial markets (Appendix Box 1). Tight management of exchange rates is also motivated by a

desire to avoid the volatility that can come with thin foreign exchange markets and sizeable foreign

exchange inflows and outflows—especially given the high exchange rate pass-through to inflation.

17. Small states are somewhat more likely to be in fragile situations. Nearly one-third of

small states are categorized as being in a fragile situation (Annex Table 1), compared to about one

in eight for developing countries with populations of more than 10 million. In these countries,

administrative capacity, which is already challenged by small country size, may be further undercut

by domestic conflict, a fractious political setting, and questions of political legitimacy. Staff working

on small countries in fragile situations can find relevant guidance on dealing with the special

challenges in such countries in the May 2012 “Staff Guidance Note on the Fund’s Engagement with

Countries in Fragile Situations” (IMF, 2012a). In addition, the recent policy paper “Building Fiscal

Capacity in Fragile States” (IMF 2017f) analyzes the main characteristics of fragile states and assesses

technical assistance (TA) and capacity development in building or rebuilding fiscal policy

management drawing on key lessons from their experiences.

18. Despite many common characteristics, there is considerable heterogeneity across small

states. Thus, comparing the Caribbean and Pacific island small states, those in the Caribbean tend to

have higher per capita incomes but also higher public debt burdens. Over the period 2000–2016,

Pacific island small states (PICs) GDP per capita growth doubled whereas income growth in the

Caribbean fell markedly relative to previous decades. PICs are much more reliant on development

assistance than other Caribbean counterparts (Box 3).

14 In addition, some small states like Kiribati, adopt foreign currency as tender.



http://www.imf.org/en/Publications/CR/Issues/2017/06/14/Multi-Country-Report-Building-Fiscal-Capacity-in-Fragile-States-Case-Studies-Press-Release-44982

http://www.imf.org/en/Publications/CR/Issues/2017/06/14/Multi-Country-Report-Building-Fiscal-Capacity-in-Fragile-States-Case-Studies-Press-Release-44982



Box 3. Regional Characteristics of Small States 1/

Caribbean countries

Most small states in the Caribbean are upper middle-income (as defined by the World Bank, see Annex

Table 1), and median incomes for the region are almost three times higher than in Pacific island countries

(PICs), though this gap has closed over the past decade. Against this, median public sector debt (80 percent

of GDP in 2016) is almost three times the median for PICs. While Caribbean small states’ per capita growth

performance has slumped since 2000, PICs per capita growth almost doubled.

Although no Caribbean small state is defined by the World Bank as being in a fragile situation, the six Eastern

Caribbean Currency Union (ECCU) countries are among the top 10 most disaster prone countries in the world

as measured by disasters per land area or population (hurricanes are a major threat).2/ The effects of natural

disasters on growth and debt are accordingly significant.

Indigenous banks in the ECCU are structurally weak.3/ Poor risk management practices, coupled with

inadequate supervision and regulation, have led to capital shortfalls in most of these banks.

Pacific Island Countries (PICs)

The Asia and Pacific region includes some of the world’s poorest small states. PICs are notable for being

remote, widely dispersed, and lightly populated. With poor connectivity and high transport costs, they are

not well integrated into the broader Asian regional economy; remoteness has limited their ability to grow

through exports. Like Caribbean small states, PICs are severely affected by natural disasters and are

vulnerable to the impact of climate change, including rising sea levels. About one-third of PICs are defined

by the World Bank as being in fragile situations (Annex Table 1).

PICs face major capacity constraints, even by small states standards. For example, low rates of school

enrollment contribute to low educational achievement. Financial depth is generally below that of other small

states, with limited access to private credit a key impediment to inclusive growth.

PICs are much more heavily reliant on aid than Caribbean small states. Typically, PICs face higher volatility

than other small states with regard to Official Development Assistance (ODA) flows, per capita income

growth, terms of trade, current account balances, and fiscal revenues.

_________________________________

1/ This box is limited to the regional characteristics of Caribbean countries and PICs as the sample size from other regions is

small.

2/ See Rasmussen (2006), “Natural Disasters and Their Macroeconomic Implications,” pp. 181–205, in “The Caribbean: From

Vulnerability to Sustained Growth,” ed. by R. Sahay, D. Robinson and P. Cashin (Washington: International Monetary Fund).

3/ These banks are defined as being locally owned and locally incorporated.

Table: Selected Indicators of Small States in the Caribbean and Asia Pacific

Trade Openness

(X+M/GDP)

Net ODA received

(% of GDP)

Private Credit*

(% of GDP)

Public Debt

(% of GDP)

1980-99 2000-16 1980-99 2000-16 2016 2014 2015 2016

Caribbean SS 2452 7439 3.2 1.3 93 2 56 80

PICs 1441 2825 0.9 1.6 101 17 38 32

Note: *Private credit (% of GDP) refers to domestic credit to private sector (% of GDP).

GDP per capita

(current US$)

GDP per capita growth

(annual %)Country Group

https://www.imf.org/external/pubs/nft/2006/cvsg/cvsg.pdf




PRIORITIES FOR POLICY DIALOGUE

This section identifies policy issues likely to be particularly important in the Fund’s surveillance

and program-related work on small states.

A. Growth and Job Creation

Policies to strengthen growth and job creation are a priority.

19. The Executive Board and management have highlighted the need for an explicit focus

on growth in the context of small states.15 This discussion and the authorities’ policy agenda

should be clearly presented in country staff reports.16 The implications for staff are discussed further

below and in Box 4.

20. Staff teams should discuss growth issues for specific sectors and consult appropriately

with other development partners. In discussing the macroeconomic outlook, teams need to be

conversant with the economics of the dominant industries (e.g., tourism, offshore financial sector,

and resource extraction), often acquiring greater sectoral expertise than would be typical for larger,

more diversified economies. Exchange of cross-country experiences would be beneficial in this

context. That said, staff should limit specific policy advice to areas that fall within the Fund’s

mandate and maintain emphasis on the contributions to growth made by promoting a

macroeconomic and financial environment that is conducive to investment and efficient allocation

and use of resources. For detailed industry advice, Fund staff will commonly need to rely on

expertise from other development institutions.

21. Improved growth performance will typically require a stronger private sector

contribution. Small states tend to feature large public sectors, with state ownership of key

economic assets as well as extensive public intervention. This has its origins in efforts to fill gaps

where the private sector is deterred by small market size and in steps to provide social protection

against external shocks. However, public sector intervention has often reached a scale that deters

new private sector investment. Teams working on small states should take these factors into account

when advising on growth-promoting strategies. Typically, the process will involve a rebalancing of

public and private roles, with a closer working relationship between the two sectors, including

leveling the playing field for new private sector entrants. In some cases, public infrastructure

investments may be a priority, provided that they are consistent with fiscal and debt sustainability. In

identifying impediments to private sector activities, teams should draw on available resources,

including the Multilateral Development Banks (MDBs). Given the limited initial private sector role,

15 See presentations to small states regional conferences by DMD Shafik in the Bahamas in September 2013 and by

DMD Zhu in Vanuatu in November 2013. The Board has stated, with regard to the Fund’s engagement with small

states, that fostering improved growth should be an important priority.

16 See Board paper Guidance Note on Jobs and Growth Issues in Surveillance and Program Work (IMF, 2013f).

http://www.imf.org/external/np/speeches/2013/091913a.htm

http://www.imf.org/external/np/seminars/eng/2013/PIC/




the supply response to structural reforms may be slow and teams should be appropriately cautious

in developing medium-term growth projections.

22. Job-creation is a priority for small states. With sluggish growth and limited job

opportunities, small states are characterized by high unemployment rates and outward migration by

the better-educated (particularly in PICs). While this generates sizeable inward workers’ remittances

that help support the balance of payments, it reduces the growth dividend from educational

investments. Guidance on macroeconomic policies that can help translate growth into job creation is

provided in the “Guidance Note on Jobs and Growth Issues in Surveillance and Program Work” (IMF,

2013f).17

23. The specific labor market institutions of small states merit attention. In many small

states, there is significant brain drain, the public sector provides the majority of formal sector

employment, and wage levels can be relatively high. Staff should investigate how public

employment and public wages affect the labor markets and the process of wage settlements and

contracting in the rest of the economy. Public wages and high levels of remittances may create a

reservation wage that undercuts the ability of the private sector to hire employees at wage rates

consistent with competitiveness in domestic or export markets. Accordingly, measures to reduce the

cost of the public wage bill may have the added benefit of enhancing overall competitiveness. At the

same time, where possible, the long-term goal should be a virtuous circle of a larger economic

contribution from the private sector, stronger productivity growth, better-paid jobs, and reduced

migration of the better-educated. This typically requires structural transformation and

diversification, although opportunities for diversification may be limited because of small scale and

other impediments linked to small states.18 At the same time, migration and remittances will

continue to play an important role in the economic development of many small states, and

consideration should be given to options for maximizing the associated benefits.

24. Tourism and remittances could be better leveraged to support growth and stabilize

output. In many small states, tourism tends to be dominated by large operators, and have rather

weak linkages to the domestic economy. While these linkages are conditioned by the narrow

production base and market size, vocational education and strategic targeting of agriculture and

services can help enhance tourism spillovers into the economy. Remittances, typically a-cyclical,19

could help support consumption stability in downturns, and small states should look for ways to

facilitate their inflow, including through mobile banking and improved payment systems. In addition,

diaspora bonds remain an option to finance public investment.

17 See also “Jobs and Growth—Analytical and Operational Considerations for the Fund” (IMF, 2013e).

18 See Board paper on structural transformation in LICs (IMF, 2014b).

19 De, Kose, and Yousefi (2016).



https://www.imf.org/external/np/pp/eng/2014/030514a.pdf



Box 4. Explicit Growth Focus in Small States 1/

Breadth and reporting of discussions. Fund staff should explicitly discuss the growth agenda with the authorities. The discussion

should cover: (i) the effects of fiscal, monetary, and exchange rate developments on growth and employment; (ii) the outlook for

economic growth (if data allow, from both the demand and the supply side, and with a discussion of multipliers); (iii) vulnerability of

small states to natural disasters and climate change underscoring associated macroeconomic effects (lower investment, lower GDP

per capita, higher poverty and more volatile revenue base); and (iv) the envisaged policies and ex ante disaster risk reduction

strategies to build resilience and support growth (macroeconomic policies including public investments, structural reforms, etc.).

These discussions should be given appropriate prominence in the Fund’s surveillance and program documentation.2/

Country specificity. The focus and ambition of the growth and resilience building agenda will depend on the most critical growth

impediments and vulnerabilities in a given country (e.g., energy costs, overvaluation, crowding out, infrastructure, exposure to

natural disasters, and climate change), the goals of a possible Fund-supported program, and the government’s preferences and

implementation capacity.

Program conditionality. Program conditionality should focus on measures to strengthen growth performance, where this is needed

to solve a country’s balance of payments problem and achieve medium-term external viability while fostering sustainable economic

growth. While Fund staff should help countries design strong pro-growth policies with a focus on disaster risk reduction and

preparedness, Management’s call for an explicit growth focus in Fund-supported programs of small states is not intended to extend

or intensify overall Fund conditionality. Conditionality should remain parsimonious and macro-critical.

Competitiveness. Staff should explore the extent to which public sector dominance and the challenge of scale economies adversely

affect competitiveness. It should assess to what extent sub-par growth reflects unduly elevated cost levels, and should explore

options to improve the latter, if needed. Policies to improve relative prices should include exchange rate adjustment (if an option) or

measures supportive of internal devaluation (if not) (see Appendix Box 5 for details). Efforts to improve the overall business climate

could include moving from industry-specific tax incentives to a more generally business-friendly system with a broad base and lower

tax rates. Regional initiatives can also be considered, such as efforts to reduce tax competition or to maximize revenue for fishing

licensing fees (such as the Nauru agreement in the PICs)3/. The authorities may want to complement broad-based reforms with steps

to remove obstacles to growth for key sectors (e.g., skills, infrastructure, and regulation).

Implications for fiscal adjustment. Efforts to deliver an explicit focus on growth should be consistent with goals for

macroeconomic stability needed to underpin confidence and durable growth and resilience building to withstand exogenous shocks.

Where additional public spending, risk-reducing investment and contingency planning for disaster intervention (or delayed fiscal

consolidation) could have a positive growth impact, this should continue to be assessed from the perspective of available financing,

including contingency financing plan, and implications for fiscal and debt sustainability. More generally, it is important to strengthen

growth-friendly fiscal frameworks aimed at: (i) preserving strong fiscal fundamentals; (ii) minimizing fiscal rigidity and lowering

recurrent spending to create fiscal space for growth-enhancing capital spending; (iii) improving the spending mix towards human

and capital investments; and (iv) adopting budget and investment practices to foster returns on capital spending.4/

Climate Change Policy Assessment (CCPA).5/ On a pilot basis and within their respective mandates, the IMF6/ and the WB are

collaborating to conduct assessments of the macroeconomic and sectoral aspects of climate change policies of small states. These

IMF-WB joint assessments could help showcase small states’ policy efforts and improve their access to global climate funding in the

context of their national climate change strategies to meet commitments under the Paris Agreement. Mitigating carbon emissions—

through carbon taxation and energy subsidy reforms—and efficiently managing costly public risk reduction investments are specific

areas where Fund analysis and policy recommendations can help small states in addressing the challenges of climate change.

Outreach. Clear and upfront outreach will be important—to clarify the role of the Fund and the nature of the Fund’s commitment to

include an explicit growth agenda and resilience building aimed at ex ante disaster risk reduction strategies in program design.

The 2015 Guidance Note for Surveillance under Article IV Consultation provides operational guidance on a range of structural

issues in surveillance, including climate change.7/ The note provides detailed guidance, suggestions and references in areas covered

in surveillance including risks and spillovers, fiscal policy, macrofinancial and monetary policy, BOP stability, structural policies,

including climate change, and data issues.

________________________________________

1/ Contributor: Jan Kees Martijn.

2/ See Board paper Guidance Note on Jobs and Growth Issues in Surveillance and Program Work (IMF, 2013f). 3/ The Nauru agreement brings together eight PICs to sustainably manage tuna (Federated States of Micronesia, Kiribati, Marshall Islands,

Nauru, Palau, Papua New Guinea, Solomon Islands, and Tuvalu).

4/ See Macroeconomic Developments and Selected Issues in Small Developing States (IMF, 2015a).

5/ See Small States’ Resilience to Natural Disasters and Climate Change—Role for the IMF (IMF, 2016a).

6/ See Managing Director’s Statement on the Role of the Fund in Addressing Climate Change (IMF, 2015c) and “After Paris, Fiscal,

Macroeconomic and Financial Implications of Climate Change”, (Farid and others, 2016).

7/ See Guidance Note for Surveillance Under Article IV Consultation (IMF, 2015b).

http://unfccc.int/paris_agreement/items/9485.php




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B. Resilience to Shocks

Staff should advise small states on how to tailor macroeconomic policies to promote resilience to

shocks and enhance sustainability, with the support of Fund TA and capacity building activities.

25. Staff's macroeconomic analysis should give prominence to potential shocks. A first step

is to identify the potential sources of exogenous shocks and their relevant transmission channels.

Relevant risks include natural disasters, supply and terms of trade shocks to core industries, revenue

volatility, and vulnerability of workers’ remittance inflows to economic cycles in host countries.

Having identified potential risks, consideration can be given to the appropriate balance between

self-insurance (through development of strong fiscal and balance of payments buffers), external

insurance (through formal sovereign insurance mechanisms or reliance on optional support from the

International Financial Institutions (IFIs) and bilateral donors), and private sector involvement in risk

reduction (with the latter backed, to a varying degree, by private insurance cover).

26. Macroeconomic resilience will typically require adequate fiscal and external buffers to

weather shocks. The 2016 policy paper on small states’ resilience to natural disasters and climate

change provides a conceptual framework and implementation roadmap to build adequate buffers as

a critical part of disaster contingency planning.20 More generally, it is important to strengthen the

fiscal framework to “see through the cycle” and help insulate the budgetary spending from revenue

volatility. The pace of accumulation of buffers should be considered from a cost-benefit assessment.

Where priority spending would need to be cut to boost savings and build buffers, a more gradual

accumulation of buffers could be considered drawing on new revenue measures, or provision for

future natural disasters in the annual budget thereby strengthening fiscal buffers. Shocks that

require a period of temporary higher public spending (disaster relief, say) can be covered in part

through an explicit contingency in the budget, whereas larger shocks would require access to debt

financing. In the balance of payments, buffers can be provided by contingent lines of credit or, more

likely, by holding an official reserve position to allow draw-downs to finance temporary balance of

payments shortfalls without destabilizing confidence.

27. Fiscal rules should be geared to support recovery efforts while maintaining fiscal

sustainability. Fiscal rules, if adopted, should ideally include specific provisions for how targets (e.g.,

deficit ceilings) would be adjusted in the event of an external shock, and how policies would be

brought back in line with the fiscal rule in the post-shock period (Appendix Box 2).21 Where fiscal

policy is guided by a public debt ceiling, policies should be geared at maintaining sufficient space

below this ceiling to weather a period of elevated borrowing.

28. Aspects of public finance management can also be strengthened to help manage

shocks. Procedures that allow for monitoring and transparent reporting of the use of emergency

disaster assistance may be needed to ensure repeated support from development partners.

20 “Small States’ Resilience to Natural Disasters and Climate Change—Role for the IMF”, (IMF, 2016a).

21 Absent this specificity, large shocks can lead policies to deviate from the fiscal rule for prolonged periods, with no

mechanism to enforce the difficult transition back to compliance.




Similarly, the future cost of disaster-related public spending can be treated as a public contingent

liability for budgetary purposes, helping to integrate risks into the cash and debt management

framework. In addition, containing non-discretionary spending (such as the public sector wage bill)

will help to enhance fiscal flexibility in the face of adverse shocks.

29. Sovereign insurance mechanisms are a new option, but typically provide only marginal

risk mitigation. In practice, these facilities and schemes have required donor capitalization to help

reduce the cost of premia to participating countries, and even on this basis prove to be an expensive

insurance option (Appendix Box 3). The insurance cover needs to be complemented with the use of

other financial instruments as it is not designed to cover all disaster losses (it covers only emergency

losses but not the loss of assets).

30. The Fund can assist countries to identify disaster-related financing needs. This could

involve quantifying financing needs, based on an analysis of disaster risks and vulnerabilities and

their possible fiscal impact. Financing needs could be segmented by date, distinguishing urgent

financing needs (under three months), short term needs (under one year), and medium term needs

(over one year). This would help to identify the necessary scale of fiscal buffers, access to financing,

and/or risk transfer arrangements. Appendix Box 4 explores the different elements of the disaster

risk financing tool kit in more detail.

31. Programs designed to help recovery from natural disasters or increase ex ante

resilience may also be an opportune time to pursue growth-enhancing reforms. Climate-smart

public investment and financial deepening can help countries build social and economic buffers to

weather future disasters. To this extent, disaster planning may represent an opportunity to revisit

obstacles to growth that might be difficult to address in a lower-risk environment.

32. Climate change poses specific risks for small states. Low-lying atolls (such as Kiribati,

Tuvalu, and the Marshall Islands) are at risk from rising sea levels and countries currently subject to

hurricanes, cyclones, and flooding may experience more frequent and extreme weather events in the

coming years.22 These risks require long-term disaster mitigation plans that can be costly to public

resources. Although the global community has pledged sizeable resources to help countries meet

these costs, disbursements have been very limited so far, financing arrangements are convoluted,

and access is limited by lack of capacity. In considering fiscal space, Fund teams should be sensitive

to the long-term implications of climate change for the public investment needs of small states and

should be ready to consider how these might be financed (e.g., with external resources, if available,

or through domestic revenue mobilization, if not).

33. Resilience building advice will need to be appropriately tailored for small states in

fragile situations. For these cases, teams should also be guided by Staff Guidance Note on the

Fund’s Engagement with Countries in Fragile Situations (IMF, 2012a) and findings of the policy paper

22 For details see Office of the High Representative for the Least Developed Countries, Landlocked Developing

Countries and Small Island Developing States (UN-OHRLLS, 2009).



http://www.preventionweb.net/english/professional/publications/v.php?id=34040



Building Fiscal Capacity in Fragile States—Case Studies (IMF, 2017f).23 In general, policy advice

geared to fostering resilience would need to: (i) pay attention to political economy considerations;

(ii) tailor TA and capacity building efforts in fiscal policy management to achieve fiscal stability,

financial control and secure “own” resources with due consideration to the state of fragility—midst

of conflict/disaster, most fragile/post conflict or disaster and fragile/stable but vulnerable; (iii) tailor

the nature and pace of reforms to the need for security and social cohesion as well as levels of

capacity; (iv) promote approaches conducive to sustained engagement with IFIs; and (v) ensure close

coordination with other IFIs and donors.

C. Overall Competitiveness

Staff will need to explore options to enhance competitiveness as the current levels are often

inadequate, leading to sub-par growth. Political economy aspects of structural reform design and

sequencing may require more careful attention in the context of small states.

34. Structural inefficiencies, such as high energy and transportation costs, limited private

sector development, and labor market rigidities, are key challenges to raising growth and

improving competitiveness. Policy advice to address these challenges could include facilitating

domestic wage and price cuts to improve price competitiveness, such as in the tourism sector, and

implementing structural reforms to improve the business environment, such as land tenure reform

or remittance market reforms.24, 25 Staff should also assess the desirability and feasibility of internal

fiscal devaluations to improve competitiveness.26 Currency devaluation is another element of the

toolkit to address broader macroeconomic imbalances in several countries.

35. The role of exchange rate policy in strengthening competitiveness merits careful

consideration and communication. The question of when and how to implement exchange rate

adjustment in small states is one of the more complex issues that national authorities face, and

careful consideration of the country context is needed in addressing this issue (Appendix Box 5):

• In assessing competitiveness of tourism-dependent economies, staff should seek to go beyond

approaches based on EBA-lite type analysis that are often not adequately tailored for application

in small states.27

23 See also IMF Engagement with Countries in Post-Conflict and Fragile Situations—Stocktaking (IMF, 2015d).

24 PICs face the highest cost of sending remittances in the world; these costs can often be reduced by expanding

competition, such as by allowing more remittance service providers or elimination of exclusivity agreements.

25 See Macroeconomic Developments and Selected issues in Small Developing States (IMF, 2015a).

26 In the Eastern Caribbean Currency Union (ECCU), the option of fiscal devaluation was assessed as unlikely to have a

substantive impact on wage costs given limited scope to reduce payroll taxes in the region.

27 More details can be found in External Assessments in Special Cases (IMF, 2014c); and Bilateral Surveillance Guidance

Note (IMF, 2012b).



https://www.imf.org/external/pubs/ft/dp/2014/dp1401.pdf





• Where competitiveness issues arise, consideration of exchange rate adjustment needs to weigh

the potential adverse impact on inflation discipline against the alternative costs of pursuing cost

reductions to restore competitiveness.

• Given the openness of small states, currency adjustment tends to quickly pass through to

inflation through imported goods prices. Where domestic production has an import component

(e.g., foodstuffs for the hotel industry), this would erode initial improvements in competitiveness.

• The eventual impact of currency adjustment on competitiveness will likely depend on the degree

of pass-through to domestic wages. This, in turn, may depend on public sector wage policy,

given the signaling role that the state sector has in many small states.

• Where diseconomies of scale and structural distortions are severe, improvements in price

competitiveness may not elicit a large supply response. In such cases, improvements in relative

prices would need to be combined with structural policies to foster a larger supply response.

• Exchange rate adjustment can potentially benefit foreign-owned sectors disproportionately,

underscoring the need for staff to assess the impact of adjustment on both GDP and GNI.

36. Regional trade and cooperation may be of particular value to small states. The loss of

earlier trade preferences in advanced economy markets (exports of bananas, sugar, etc.) has been a

key factor behind the less favorable growth performance of small states over the past decade,

particularly in the Caribbean. Although Pacific island economies are so remote from each other that

the cost of regional trade is very high, regional trade facilitation programs are currently being

implemented that can reduce transaction costs. For the Caribbean, there may be scope to benefit

from regional trade infrastructure arrangements, including exploiting the prospective growth of

regional container traffic following expansion of the Panama Canal and the proliferation of

e-commerce, which will circumvent local monopolies and reduce prices paid by consumers. There is

also scope to promote regional collaboration in promoting access to common external markets and

to reduce the cost of public service delivery in some cases through regional cooperation in air/sea

transport (air traffic control, say), marketing the region together, and negotiating as a group with

large trade partner countries and companies. The challenge here is that regional institutions can be

politically attractive, yet often fail to achieve concrete economies of scale. The potential fiscal

challenges brought by regional trade integration in terms of lost revenue would have to be

addressed by broadening the tax base and strengthening tax administration and compliance.

37. The Fund has stepped up its efforts to better integrate macroeconomic implications of

structural reforms into analytical work to support policy dialogue. A core element of the Fund’s

analytical work has focused on assessing the impact of structural reforms on economic outcomes

(such as, growth, productivity, employment, and inequality). Staff working on small developing

states with narrow economic base will need to ensure that Fund analysis and policy advice aims to

facilitate structural reforms—e.g., energy subsidy reform, labor market policies, fiscal structural

reforms, infrastructure investment, insolvency reform, or financial deepening—which help to



contribute to fostering competitiveness and boosting growth.28 This, in turn, provides a stronger

basis to leverage regional knowledge of policy experiences, while ensuring Fund analysis and policy

advice is tailored to small developing states’ specific circumstances.

D. Workable Fiscal and Debt Sustainability Options

Staff will need to find the appropriate balance of fiscal consolidation while promoting growth,

particularly in heavily indebted countries. In designing growth-friendly fiscal policies, consideration

should be given to small developing states’ specific needs, circumstances and administrative capacities.

38. Restoring fiscal and public debt sustainability are key challenges, notably in the

Caribbean. In situations where debt burdens are excessive, restoring debt sustainability invariably

would require stronger fiscal frameworks and sustained fiscal consolidation. Empirically, fiscal

consolidation has been more successful when (i) the initial adjustment was larger; (ii) adjustment

emphasized spending reductions—in particular, on current expenditure; and (iii) fiscal rules were

present.

39. Proper consideration should be given to several factors that determine the

composition and pace of fiscal adjustment. These include the size of fiscal multipliers, a country’s

position in the economic cycle, and short- vs. long- run concerns. In addition, measures to develop

or strengthen social safety nets may be warranted to limit the potential equity implications of the

proposed fiscal adjustment. To be successful, fiscal adjustment efforts typically need to be

supported by capacity building activities and accompanied by bold growth-enhancing structural and

governance reforms; they may also require more exchange rate flexibility. Staff are encouraged to

recommend sustained fiscal adjustment where needed, with supporting policies and structural

reforms. That said, fiscal consolidation need to be carefully calibrated in prolonged low-growth

environments—for example following the global financial crisis—where fiscal consolidation is likely

to have a negative short-term impact on growth with a potential long-term impact on output

through low investments.29 Moreover, countries that are not under market pressure should proceed

with gradual fiscal consolidation, anchored in a credible medium-term plan. Greater focus can also

be given to ROSCs (Report of the Observance of Standards and codes) and PEFAs (Public

Expenditure and Financial Accountability) to formulate policy dialogue.30

40. Citizenship programs can be a significant source of revenue, but their benefits should

be weighed against potential drawbacks.31 Citizenship programs have been a source of

substantial inflows, especially in the Caribbean, where in class-leader St. Kitts and Nevis inflows to

the public sector alone neared 25 percent of GDP in 2013. Other small states, such as Dominica,

Antigua and Barbuda, and Comoros, have also experienced significant inflows. However, inflows

28 See “Structural Reforms and Macroeconomic Performance: Initial Considerations for the Fund” (IMF, 2015e).

29 Fiscal Policy and Long-Term Growth (IMF, 2015h)

30 Fiscal ROSCs have been undertaken in over half of larger countries but only 20 percent of small states.

31 Gold and El-Ashram (2015).





related to these programs can be vulnerable to sudden stops, exacerbate external vulnerabilities, be

misused for criminal purposes and threaten financial stability. As such, they should be managed

carefully and be transparent and accountable, with a view to maintaining the reputation of the

program and spreading the gains into the longer term.

41. Staff should be ready to help identify solutions to deal with high debt burdens,

including debt restructuring, if needed. Some individual small states may find that achieving debt

sustainability through fiscal consolidation and growth alone is not feasible. The amounts of

financing available and the ability to sustain adjustment may prove insufficient to deliver the needed

debt reduction. In such cases, debt restructuring may need to be considered, in support of the

country’s fiscal consolidation and other policy efforts (Annex Table 6 reviews selected debt

restructuring operations in small states). Drawbacks associated with debt restructuring must also be

weighed—in particular those related to long-term growth (which may be dependent on future

financial market access) and financial stability (where the composition of debt and links to the

domestic financial sector can be critical).

42. The Fund’s role in debt restructuring cases is well-established, and applies equally to

small states. The Fund always recommends that the member country avoids default by remaining

current on all debt obligations to the extent possible. When the authorities decide to pursue debt

restructuring, the Fund leaves the details of the debt restructuring strategy to the debtor and its

legal and financial advisors. The Fund can, however, help the member design an adjustment

program to restore debt sustainability and ensure medium-term external viability, and can help

determine the financing envelope that informs the deliberations of the debtor and its creditors. For

small states with limited capacity, support in designing adjustment programs can be particularly

valuable. Finally, the Fund should encourage member countries to include in their international

sovereign bonds the enhanced collective action clauses and modified pari passu endorsed by the

Executive Board32 to facilitate orderly debt restructuring.

43. Staff advice may frequently be sought on public-private partnerships (PPPs). Despite

benefits, such as a technology transfer to the receiving country, an opportunity to ease financing

constraints, and improved project management, PPPs are not often utilized in small states, reflecting

the broader challenges of attracting private sector investment. Where the authorities plan to rely

more heavily on PPPs, Fund teams should be alert to the important quasi-fiscal risks that PPPs can

bring as well as the implications for monopoly power.33 Approaches to control for fiscal risks

associated with PPPs include: (i) ensuring control over approval of PPPs and strengthening the

gatekeeping role for the Ministry of Finance in assessing risks and fiscal sustainability; (ii) careful

appraisal through independent review of project feasibility and charging risk-related guarantee fees

32 See Strengthening the Contractual Framework to Address Collective Action Problems in Sovereign Debt Restructuring

(IMF, 2014d).

33 A few useful references include, (a) Public-Private Partnerships, Government Guarantees and Fiscal Risk (IMF, 2006);

and (b) Public Investment and Public-Private Partnerships: Addressing Infrastructure Challenges and Managing Fiscal

Risks (Procyclicality of Financial Systems in Asia), (IMF, 2008).


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(where provided); (iii) ensuring risk-allocation framework to parties best able to control the risk; and

(iv) identifying and budgeting for costs and potential fiscal exposure during the decision-making

process.34 Consultations with relevant staff in Fiscal Affairs Department (FAD) and the World Bank on

these issues are essential.

E. Thin Financial Sectors

Staff will need to ensure that any recommendation for the deepening of the financial sector occurs

with adequate supervision and regulation.

44. Priorities include deeper financial sectors, more competition, better service delivery,

and strengthened oversight.35 A first challenge for staff teams will be to compile relevant financial

sector data to underpin analysis, including performance indicators. About one-third of small states

and one micro states, have had a full Financial Sector Assessment Program (FSAP) since 2000–17,

compared to about three-quarters of larger states. The overall goal for Fund policy advice and

capacity development efforts in the financial sector should be to support improved growth

performance while providing a financial buffer that can help companies and individuals manage

economic shocks. Efforts to promote competition should foster rather than detract from stability,

exploiting technological and other opportunities to achieve efficient scale in banking and other

financial sector activities. An example is the East Caribbean Regional Governments Securities Market

(RGSM), which consolidates the regional trading of debt instruments for member states of the

Eastern Caribbean Currency Union (ECCU), thereby creating a single regional financial space. Efforts

to strengthen the legal framework for financial services and to implement relevant international

standards should be tailored to the challenges of small markets, their limited supervisory resources,

and reputational risks. Where fiscal positions are especially important to financial development, in

view of the sovereign’s dominant role in local markets, policy advice on fiscal and debt management

should take this into account.

45. Small states have been recently challenged by unintended financial consequences

through the disruption of correspondent banking relationships (CBRs). CBR withdrawal has

already affected the ease and cost of remittances transactions to some small states.36 Furthermore, it

presents risks to financial stability and inclusion, can increase the use of more expensive and less

transparent remittances channels, and lead to lower growth and resilience to shocks. Going forward,

staff should continue to support its member countries in addressing issues leading to and arising

from the withdrawal of CBRs and monitoring risks to help tackle the adverse impacts from the

withdrawal of CBRs and ensure financial stability and promote financial inclusion. Through

surveillance and FSAPs and providing capacity development which comprises both TA and training,

34 See Analyzing and Managing Fiscal Risks—Best Practices (IMF, 2016e).

35 See “Financial Inclusion in Small States” in Macroeconomic Developments and Selected issues in Small Developing

States (IMF, 2015a).

36 For more details see “The Withdrawal of Correspondent Banking Relationships: A Case for Policy Action”, (Erbenova

and others, 2016); see also the March 2017 Board Paper on “Recent Trends in Correspondent Banking

Relationships—Further Considerations” (IMF, 2017b).




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staff can support affected countries to help enhance their monitoring of CBRs and strengthen their

legal, regulatory and supervisory frameworks. Small states should seek to improve domestic

compliance to international AML/CFT standards. A possible alternative for remittance flow could be

to encourage transfers through mobile banking. Consolidation of small-sized banks could help

ensure sufficient levels of transaction flows, and economies of scale for due-diligence processes.

SURVEILLANCE AND ANALYTICAL WORK

Country teams working on small states may need to explore creative approaches (such as

intensified use of cross-country analysis and focusing on a narrower set of policy-relevant

issues) to overcome staffing constraints, data gaps, and, in many cases, lower frequency of

missions in comparison to larger countries.

46. Cross-departmental approaches to analytical work have proven helpful for

strengthening advice and outcomes. There are often synergies to be gained from bringing

together experience from different clusters of small states (Caribbean, Pacific islands, and African).

This may be particularly important where data limitations and methodological weakness on

macroeconomic statistics constrain the ability to learn lessons solely by looking at small states within

one area department. Also, where staffing on a given small country team is limited, a policy issue

can be tackled as part of a multi-country study with shared desk resources. To facilitate cross-

departmental analysis, periodic sharing of departmental small states work agendas will help identify

possible joint projects. Although analytical priorities will evolve, some issues that are currently

important are outlined in Box 5.

47. Given limited policy analysis capacity in small states, the emphasis of staff analytical

work should be on immediate policy-relevant issues rather than on basic research. The priority

for small states governments is analysis with concrete policy implications, usually drawing on lessons

from policy implementation in other countries. Some attention to improved information systems

and adequate data dissemination with the help of STA might be required in that context. Regional

conferences, events linked to the Annual Meetings (including the Small States Forum), and area

departments Regional Economic Outlooks (REOs) have been good options for disseminating such

work. Outreach will typically be led by area departments, including regional TA centers. Cross-

departmental events should be considered to help broaden the learning opportunities for small

states governments.



Box 5. Analytical Issues in Small States 1/

Despite advances in understanding the challenges small states face, a continuing analytical work program on

small states will remain important. Possible priorities for analysis include:

The factors behind the relative growth underperformance of small states since the late 1990s. The

reasons behind the failure of small states to match the improved growth performance of larger states over the

past 15 years are not yet fully understood, and this is a priority for further analytical work. Does this reflect a

failure by small states to adopt the macroeconomic and structural reforms that have contributed to stronger,

more durable growth in larger peers? Or were small states’ pro-growth reforms offset by a conjunction of

regional developments (such as loss of trade preferences) that have had their largest impact, coincidentally, on

clusters of small states? What are the implications for small states’ growth strategies?

The effectiveness of exchange rate adjustments in highly open small states. Are there major differences in

the exchange rate transmission mechanism that should inform policy design for small states seeking to

achieve external adjustment?

Appropriate monetary and exchange rate regime. What are the factors to be considered in advising small

states on desirable monetary and exchange rate regimes? Should small states favor a monetary regime based

on a simple monetary rule (i.e., rigid exchange rate or monetary targeting), given their limited administrative

capacity to operate an independent monetary policy.

The impact of global and regional spillovers on small states. What are the major transmission channels,

and how do these vary across small state regions? The existing strand of work by Fund staff on particular

countries and country groups would provide a strong foundation for additional work in this area.

Understanding potential advantages of small size. Much of the attention in this note has been on

overcoming the obstacles associated with small size. There may be important lessons in the development

experience of highly successful small states, including in how they have exploited particular advantages.

Overcoming scale diseconomies. Are there precedents and best practices for administrative cost-sharing or

outsourcing arrangements that can help to reduce small states’ administrative costs—particularly in the case of

micro states? For example, in managing small state sovereign wealth funds?

Financial sector benchmarking and vulnerabilities. Benchmarking could help to identify how a country’s

financial system compares to those of its peers. Diagnostics could clarify which financial services are

underprovided and which sub-segments or instruments are underdeveloped. Pinpointing vulnerabilities from

the interconnectedness intrinsic to being small and open is also needed.

Designing fiscal rules for small states. How might fiscal rules be best tailored to use in small states, given

the volatility they experience in revenues and expenditures?

Understanding and managing high aid volatility. What is behind the higher aid volatility observed in small

states? Is there a particular role for the Fund, World Bank, or other IFIs in donor coordination or in helping

small state country authorities to manage aid volatility?

Dealing with shocks. Given the susceptibility to external shocks, including natural disasters and climate

change, how can small states build resilience to deal with them? Adequacy of fiscal and external buffers to

cover natural disaster-related shocks? What are the contingency plans in place to strengthen preparedness?

What are the financing plans with identified creditors, insurance, catastrophe bonds, or grants in place for

small, moderate and severe disasters?

___________________________

1/ In selecting analytical work, staff is encouraged to focus on the needs of their respective countries.



48. Analytical Toolkits. Fund staff should provide small states authorities with economic tools

to help guide their policy analysis. This may be particularly important where the policy making

capacity in the country is thin. Where tools are provided, they should ideally be relatively easy to use

with standard spreadsheet or econometric software. In cases where Fund tools are more complex

(such as the Debt Sustainability Analysis (DSA) templates and exchange rate assessment tools, for

example), the authorities may welcome workshop presentations on their usage. Consideration

should also be given to opportunities for developing more streamlined versions of Fund tools that

could be used with the more limited data available in small countries. In addition, the traditional

toolkits can be augmented to include small state specific issues.

49. The Fund has developed tools to assess small states’ risks and vulnerabilities related to

natural disasters, including the recent collaboration with the World Bank on Climate Change

Policy Assessment (CCPA) providing an assessment of small states’ preparedness for climate

change. Approaches for integrating natural disasters and climate change risks into standard Fund

analysis are summarized in Box 6. This advice builds on past work on small states, where staff have

often explicitly integrated risks and vulnerabilities from natural disasters into projections and policy

advice related to climate change. Some small states have participated in the Fund’s climate pilots

and the CCPA pilots which focused on macro-critical priorities related to climate mitigation and

adaptation (Box 7).37 The CCPA is a joint IMF-World Bank assessment of small states’ preparedness

for climate change accompanying a country’s Article IV consultation or program review document as

a stand-alone selected issue paper to the Executive Board. This provides an opportunity to integrate

climate issues to help develop a coherent policy framework and catalyze climate change financing.

50. Debt sustainability assessments take on additional importance in disaster-vulnerable

countries. Post-disaster recovery and rebuilding programs typically often include a debt-financed

element, and the amount and terms of such financing should be carefully reviewed. Experience

suggests that rapid debt accumulation is not uncommon in countries experiencing a series of

disasters. This may reflect a weak underlying fiscal stance, with disaster-related borrowing

exacerbating already weak debt dynamics. It may also reflect looser scrutiny of borrowing plans in a

post-disaster setting. DSAs should be based on assumptions about trend economic growth and the

future fiscal stance that incorporate the risks of adverse shocks from further disasters over the

projection period. For projections, such as those used for the LIC Debt Sustainability Framework

(DSF) that can cover a period as long as 20 years, adjustments to reflect potential disaster effects are

critical.

37 Climate pilots include Trinidad and Tobago on reforming energy subsidies, Seychelles on improving climate

mitigation and adaptation, and St. Lucia on the development of renewable energy sources.



Box 6. Integrating Natural Disasters and Climate Change into IMF Macro-Frameworks

and Risk Analysis 1/

• Macro criticality. In countries where natural disasters and climate change significantly affect economic

performance, Fund analysis (of the macro framework, debt sustainability, external imbalances, etc.) should

make specific allowance for such shocks, whether in the short- or medium- to long-term.

• Data sources and perspectives. Staff will usually need to combine EM-DAT data, country economic data,

and perspectives from country experts to develop a full picture of the potential scale, frequency, and

macro transmission channels of natural disasters and climate change. The assumptions adopted for

analytical purposes should be clearly documented.

• Macro baselines. Medium- to long-term baselines used for assessing policy sustainability (e.g., DSAs)

should reflect economic performance not just in good years, but also factoring in the economic impact of

future natural disasters. A range of approaches can be used to reflect the “average impact” of disasters,

including using historic averages for key variables to develop tailored adjustments based on assumed

risks and transmission channels.

• Alternative shocks scenarios. The policy implications of adverse scenarios should be assessed. Risks

around the baseline and the adequacy of fiscal and external buffers should be evaluated using alternative

scenarios calibrated to reflect “average” and/or “tail risk” natural disasters.

• Financial risks, reserve adequacy, and general equilibrium modeling. Tailored approaches can be

used to explore financial sector risks, following practices applied in recent FSAPs. The current reserve

adequacy tool can be readily adjusted to reflect the impact of natural disasters. And the Debt, Investment,

and Growth (DIG) model could be used to explore the dynamic adjustment path following a disaster.

___________________________

1/ See Small States’ Resilience to Natural Disasters and Climate Change—Role for the IMF, (IMF, 2016a).

51. The alternative shock scenarios would provide the dynamic response to a large shock.

A standard scenario would involve an “average” disaster, while tail risks could be explored by

modelling the sort of disaster that might occur once every 50 or 100 years.38 The scenario would

trace the immediate and subsequent response of key macro variables, typically spanning several

years of post-disaster reconstruction. Country teams are encouraged to include customized country

scenarios in DSAs. The revised LIC DSF toolkit which will be fully operational in 2018 will provide

easier assessment of the implications of natural disasters and climate change shocks on debt.39

52. Macro-financial linkages should be considered. In principle, savings in the banking

system provide an important buffer for the private sector to weather disasters. The quality of bank

assets could suffer a serious blow if the natural disaster impacts their clients. For example, crop

destruction may make it difficult for farmers to repay agricultural credits, leading to an increase in

non-performing loans. Severe disasters may also undermine the normal functioning of the financial

system in the short run, acting to delay the recovery process.40

38 Since individual country data are not available to clearly define the scale of “a once in 50 years” disaster, these

estimates would typically be informed by data across a range of countries and periods.

39 Review of the Debt Sustainability Framework for Low-Income Countries—Proposed Reforms, (IMF, 2017i).

40 The staff report for Vanuatu’s 2015 Article IV and RCF/RFI requests provided good practice in discussing financial

linkages and policy reactions to Cyclone Pam. In this case, commercial banks allowed for voluntary suspension of

debt service over two–three months, and an emergency borrowing facility (along with other liquidity measures) was

activated by the central bank.

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Box 7. Pilots on Climate Change /1

Two sets of climate change pilots are currently underway: (1) the “initiative to operationalize work on the emerging

macro-critical issues of inequality, gender, and energy/climate” which began in 2015; 2/ and (2) the Climate Change Policy

Assessment for Small States (CCPA) which began in early 2017. 3/

The Operationalizing Emerging Issues pilots required staff to commit to a special focus in the Article IV consultation on

climate/energy (or other emerging issue). As of April 2017, nine countries had completed climate/energy pilots, including

two small states (St. Lucia and Trinidad & Tobago).

o St. Lucia’s 2017 staff report included a discussion of the development of renewable energy sources and of the costs of

natural disasters, and their internalization in the macroeconomic framework.

o Trinidad & Tobago’s 2016 Article IV consultation included a Selected Issues paper on fuel subsidies. The discussion

included a focus on the environmental (and traffic decongestion) benefits of phasing them out—which required

estimating the composition of post-tax subsidies, including the contribution of the subsidies to global warming—and

some discussion of climate finance.

The CCPA for Small States is a joint IMF-World Bank assessment of small states’ preparedness for climate change. The first

pilot, for Seychelles, was attached to the 2017 Article IV; the second, for St. Lucia, is expected to be completed in early 2018.

o The CCPA takes stock of small states’ general preparedness for climate change, their mitigation commitments under the

Paris Accord and strategy for achieving these, their adaptation needs and strategy, national processes, and financing. It

integrates the expected impact of climate change on a country and its needed policy responses into the macro-

framework and the DSA—key for small states where the costs of confronting climate change risk are very large.

o The CCPA is designed as a Q&A document, intended to be relatively short (with any additional work by Fund or Bank

staff attached as appendices). 4/

o The Seychelles pilot was delivered by the Article IV team and an FAD carbon tax mission, both with World Bank

participation. As FAD’s carbon tax spreadsheet is converted into a user-friendly tool, future pilots will not have to rely

on TA support.

o For St. Lucia, the World Bank also fielded a stand-alone mission on climate-modeling, suggesting that the CCPA can be

a useful organizational umbrella for pursuing the IFIs’ analytical agenda on climate change.

o The CCPA includes a (non-exhaustive) list of the country’s priority financing and capacity-building needs, with the goal

of signaling to the international community where it can help the country build resilience to climate change.

____________________

1/ Prepared by Adrienne Cheasty and Ian Parry.

2/ See the Managing Director’s Statement on the Work Program of the Executive Board, (IMF, 2017d).

3/ The CCPA was initiated by the Board paper on Small States’ Resilience to Natural Disasters and Climate Change—Role for the IMF, (IMF,

2016a).

4/ See Seychelles—Climate Change Policy Assessment (IMF, 2017e), pp. 57–58, for the questionnaire.

53. External sector assessments should take into account buffers needed to cope with

vulnerability to natural disasters. As noted earlier, the balance of payments would typically

deteriorate following a natural disaster reflecting lost exports and additional import needs, and its

financing would rely on remittances, external grants and borrowing, and possible reserve

drawdowns. To the extent that financing is not readily available at reasonable cost, countries

vulnerable to natural disasters may need to build higher external buffers.

54. The Fund’s existing reserve adequacy assessment tools can be tailored to countries

prone to natural disasters. Of the Excel-based templates available for assessing reserve adequacy

(ARA), the ARA-CC methodology for credit-constrained economies is likely to be the most relevant

to small developing states. The guidance note discusses how the tool and approach can take into

account country-specific risk and other factors which are also relevant to natural disasters.41 These

41 See Guidance Note on the Assessment of Reserve Adequacy and Related Considerations (IMF, 2016b) and for

background and analysis in Mwase (2012).

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include: (i) expected shocks (e.g., future disasters); (ii) structural changes (e.g., investing in resilience);

(iii) alternative scenarios (e.g., a natural disaster in the next year); and (iv) risk aversion (e.g.,

precautionary incentives because of higher vulnerability to natural disasters).

PROGRAM DESIGN, AND FUND FACILITIES AND

INSTRUMENTS

A range of Fund facilities is available to meet small states’ needs. All Fund members are

eligible to access the GRA resources, and 20 of the 34 small states are also eligible for

concessional financing under the PRGT. New access limits policies under the GRA and the

PRGT have been approved over 2015–17; the quota increases agreed under the 14th General

Quota Review were largely implemented in January 2016; and the Fund has clarified guidance

on existing access policies as they relate to PRGT-eligible members in November 2016.42

55. The Executive Board approved in July 2015 a set of measures that expanded access to

PRGT resources in the context of the Fund’s Financing for Development initiative.43 This

initiative was undertaken as part of the wider effort of the international community to support

countries in pursuing the post-2015 Sustainable Development Goals (SDGs). The key measures

included:

• Raising access norms, annual and cumulative normal access limits by 50 percent in quota terms

across the concessional facilities for all PRGT-eligible countries, addressing the erosion of access

levels relative to trade, capital flows, and GDP since 2009–10;

• Rebalancing the funding mix of concessional to non-concessional financing under blended

arrangements from 1:1 to 1:2 for PRGT-eligible member countries that are presumed to receive

concessional financial support from the Fund only in the form of a blend of concessional and

non-concessional financing, recognizing that these countries typically have significantly greater

access to market funding than envisaged when the current facilities were established;44 and

• Increasing access to fast-disbursing support under the RCF for PRGT-eligible countries and the

RFI to all member countries to assist countries that are in fragile situations, affected by conflict

or hit by exogenous shocks, including natural disasters; and increasing the level of

42 The 2013 Review of Facilities for LICs (IMF, 2013g) had previously benefited small states through increased access

to the RCF (normal and shocks window), increased flexibility of PRS requirements, changed PRGT eligibility

requirements for microstates (leading to the entry of three microstates and delayed graduation of two others).

43 Financing for Development: Enhancing the Financial Safety Net for Developing Countries (IMF, 2015f).

44 Blending is presumed for PRGT-eligible countries with either (i) per capita income above 100 percent of the IDA

operational cutoff; or (ii) sustained past and prospective market access and a per capita income that exceeds

80 percent of the IDA operational cutoff provided that (iii) they are not deemed to be at a high risk of debt distress or

in debt distress (as assessed by the most recent joint Bank-Fund LIC DSA).





concessionality of such support to PRGT-eligible countries by setting the interest rate on RCF

loans at zero percent.45

56. Broadly similar increases were approved for access under the GRA in February 2016. To

ensure that no member’s access to the GRA resources would decline in SDR terms when the 14th

Review of Quota increases took effect, access limits in SDR terms under the GRA were increased by

an average of 45 percent, and annual and cumulative access limits were set at 145 percent and

435 percent of the new quotas, respectively. This moderate increase of the normal access limits in

SDR terms attenuated the erosion of absolute access limits since 2009, while preserving the rigor of

the exceptional access framework by maintaining its application at levels (relative to members’

economies) that are comparable to 2009.

57. Despite increases in PRGT and GRA access limits, the revision of individual quotas in

early 2016, which aimed at realigning quotas with economic fundamentals, has led to

differences in the capacity of small states to benefit from higher access. The amount of

financing a member can obtain from the IMF (the access limit) is set relative to quota. The

conditions for the effectiveness of the quota increases under the 14th General Quota Review were

met in January 2016 and resulted in a doubling of the cumulative quotas of Fund members to

SDR477 billion, as well as a halving of access limits under the PRGT facilities and RFI in quota terms.

However, the increase of individual member quotas varied from 39 to 220 percent.46 Among the 34

small states, the quota increase was greater than or equal to 100 percent for 13 members, ensuring

an increase in access in SDR terms by at least 50 percent for the PRGT-eligible members and

45 percent under the GRA. The remaining 21 small states had individual quota increases averaging

41 percent with corresponding access limit increases in SDR terms of 3 and 5 percent under the GRA

and PRGT, respectively.

58. In November 2016, the Board clarified the guidance on existing access policies as they

relate to PRGT-eligible members as follows47:

• Access to GRA resources. A PRGT-eligible member has the right to access GRA resources on the

same conditions as any other Fund member. Given the financial benefits from borrowing on

concessional terms, staff will continue to advise PRGT-eligible members considering Fund

financial support to borrow from the PRGT up to the applicable limits before seeking GRA

resources.

• Blending. A third of PRGT-eligible members are presumed blenders, in the sense that they are

expected, when accessing concessional resources, to do so in a blend with GRA resources. Other

45 The Board also decided in October 2016 to lock in interest rates on other PRGT facilities at zero at least until 2018.

See 2016 Poverty Reduction and Growth Trust—Review of Interest Rate Structure (IMF, 2016c).

46 As of March 2017, 179 of the 189 members had made their quota payments, accounting for over 99 percent of the

total quota increases.

47 Financing for Development: Enhancing the Financial Safety Net for Developing Countries—Further Considerations

(IMF, 2016g).

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PRGT-eligible members (non-presumed blenders) are entitled to seek wholly concessional

support up to the applicable access limits. These non-presumed blenders may also blend,

subject to an assessment, as in all cases of Fund financing, of balance of payments (BoP) need,

program strength, capacity to repay the Fund and debt sustainability.

• Access norms. Norms provide indicative guidance on what could constitute an appropriate level

of access under PRGT facilities, but they should neither formally restrict nor ensure specific

access levels. Access should continue to be determined on a case-by-case basis using the

standard criteria—that is, size of balance of payment need, capacity to repay, outstanding credit

to the Fund and record of past use of Fund resources.

59. Building a track record. Where small states need to establish, or re-establish a track record

of policy implementation, consideration could be given to a staff-monitored program (SMP). Over

the past 13 years, four small states have implemented SMPs on five occasions (Comoros (twice),

Djibouti, São Tomé and Príncipe, and Swaziland; see Annex Table 3). All were either lower-middle or

lower-income countries with significant capacity constraints. The outcomes of the SMPs were mixed.

In four out of the five cases, the SMP was successfully completed and led to use of Fund financing.

In the case of Swaziland, the SMP went off track and was not followed by a Fund arrangement. Staff

can draw on a separate note for guidance on the qualification for and design of SMPs.

60. Rapid financing. Rapid financing for urgent balance of payments needs is available through

the RCF (established in 2009 for PRGT-eligible countries) and the RFI (established in 2011 for both

PRGT- and non-PRGT eligible members).48 The RCF and RFI provide rapid financing to address

urgent BoP needs arising from a variety of circumstances, including natural disasters and shocks to

terms of trade and export demand, without phasing ex post conditionality or reviews. They are well-

suited to situations where the financing and adjustment needs are transitory and limited (due, for

example, to a temporary shock), or where an upper credit tranche (UCT)-quality economic program

is not possible, for example as a result of the member’s limited policy implementation capacity or by

the urgency of the BoP need. These instruments are attractive to small states in offering quick

financing in the event of shocks without the need to implement policies of an UCT-quality. Small

states are frequent users of the RCF due to urgent balance of payments needs associated with

shocks. During 2003–16, emergency assistance was provided on 22 occasions, to 10 different

countries (Annex Table 4). Countries tend to be multiple users, with St. Lucia, St. Vincent and the

Grenadines, and Dominica each making three drawings over the decade. More than half of the

emergency assistance was provided following climatic shocks (hurricanes and flooding) and

earthquakes, with several cases of financing for terms of trade and export market shocks and one

case of post-conflict assistance (Comoros). To further enhance the financial safety net for developing

countries, the Executive Board approved in June 2017 a new annual access limit of 60 percent of

48 Vanuatu (2015) and St. Vincent and Grenadines (2014) requested RCF/RFI blend in response to natural disasters.

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quota under the RCF and RFI for countries experiencing urgent balance of payment needs arising

from severe natural disaster-related damages of at least 20 percent of GDP (Annex Table 4).49

61. UCT-program based financing.50 The Fund’s financing in support of UCT-quality programs

has been used on 20 occasions by 11 different small states over the period 2003–16 (Annex Table 5).

The majority (13 programs) were financed by PRGT resources (under the PRGF, SCF, and ECF) while

seven programs used GRA resources (under the SBA and EFF). For both concessional and GRA

financing, most programs were for a three-year period (or longer, in a few instances). Usage has

been regionally diversified, and financing has varied from relatively modest levels to large multiples

of quota (for Maldives, Antigua and Barbuda, and St. Kitts and Nevis in 2009, 2010, and 2011,

respectively).51

62. Policy support instrument (PSI). The Fund's framework for PSIs is designed for qualifying

LICs that are PRGT-eligible and do not need Fund financial assistance, but can benefit from close

cooperation with the Fund in preparation and endorsement of their policy frameworks. Cabo Verde

is the only small state that has used the PSI. Fund support under the PSI for a three-year program

was approved in 2006 and subsequently extended to a fourth year. The PSI was successfully

concluded in June 2010 and a successor 15-month PSI was approved in November 2010 with the

two reviews completed to assist the authorities in further consolidating macroeconomic stability and

implementing structural reforms.

63. A new Policy Coordination Instrument (PCI), similar to the PSI but available to all

members, has been approved to strengthen the Global Financial Safety Net (GFSN) and the

Fund’s toolkit.52 The PCI is a non-financial instrument designed for countries seeking to unlock

financing from multiple sources and/or to demonstrate a commitment to a reform agenda. The PCI

has a duration of six months to four years, and may be extended to an overall maximum period of

four years. There is no limit on the number of successor PCIs. The PCI is available to all Fund

members, and with no ex ante qualification criteria. A member’s request for a PCI may only be

approved by the Fund if the Fund is satisfied that: (i) the member’s policies in its Program Statement

meet the standards of UCT conditionality; (ii) the member demonstrates sufficient commitment to

implement the program; and (iii) the member does not need and is not seeking Fund financial

support at the time of approval of a PCI. The PCI follows a review-based approach to monitoring

program conditionality: deviations from quantitative and reform targets will not automatically

disrupt reviews as do PCs, and waivers are not required. The completion of a program review under

the PCI would require a Board assessment that any deviation from a quantitative or reform target

49 See Large Natural Disasters—Enhancing the Financial Safety Net (IMF, 2017a).

50 For PRGT-eligible countries, the Handbook of IMF Facilities for Low-Income Countries provides coverage and

guidance on emergency financing (RCF), UCT-program based financing (SCF and ECF), the PSI, and SMPs.

51 In both Antigua and Barbuda and St. Kitts and Nevis, the high level of access was necessary to support the debt

restructuring operations. In Maldives, however, high level of access was necessary to address the impact of the global

economic crisis and restoring macroeconomic stability.

52 See Adequacy of the Global Financial Safety Net (IMF, 2016d) and Adequacy of the Global Financial Safety Net—

Proposal for a New Policy Coordination Instrument (IMF, 2017h).




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was either minor or temporary, or sufficient corrective action has been taken to achieve the

objectives of the program.

64. Poverty reduction strategies (PRS) and social safeguards in IMF-supported programs.

PRS are central to IMF-supported economic programs in LICs and small states. They assess poverty

challenges, describe how macroeconomic, structural and social policies and programs can promote

growth and reduce poverty, and outline external financing needs and the associated sources of

financing. The PRS documentation required under the PRGT for Extended Credit Facility (ECF) and

PSI-supported programs was streamlined in June 2015 and replaced by the submission of an

Economic Development Document (EDD).53 The EDD, issued to the Board with an assessment letter

of the World Bank, may take two forms: (i) an existing national development plan or strategy

documents documenting a member’s PRS; or (ii) a newly prepared document on the member’s PRS.

The Executive Board has also reviewed in May 2017 the experience of social safeguards in PRGT and

PSI-supported programs and made recommendations on good practices.54 Social safeguards

examined are split into two groups: (i) use of program floors on social and other priority spending;

and (ii) measures designed to protect vulnerable groups. The paper found that there is room to

improve the design and the use of program spending floors and that specific reform measures have

been used sparingly, yet are often the most effective tool for supporting vulnerable groups. Early

collaboration with other development partners (e.g., the World Bank), ideally during surveillance,

could strengthen existing social safeguards and help improve the design of specific social

safeguards measures under Fund-supported programs.

65. Structural conditionality. Given the limited capacity of small states governments, the

structural reform ambitions under Fund-supported programs may need to be more narrowly

focused and prioritized, in coordination with other development partners. Capacity for policy design

and implementation will be particularly constrained in small states that are also in a fragile situation.

As discussed in paragraph 16, conditionality in the latter cases should be consistent with capacity for

policy consultation, design, and implementation.

66. Data monitoring and reporting. Institutional capacity is relevant also for data monitoring

and reporting under Fund-supported programs. The lack of high quality data is often a challenge for

macroeconomic surveillance, and programs may include strengthened data provision as a key goal.

At the same time, program design may need to be tailored to the breadth and timeliness of existing

data reporting.

53 Reforms of the Fund’s Policy on Poverty Reduction Strategies in Fund Engagement with Low-Income Countries—

Proposals (IMF, 2015g).

54 Social Safeguards and Program Design in PRGT and PSI-Supported Programs (IMF, 2017c).



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CAPACITY DEVELOPMENT

Investments in capacity development (CD) will be needed for many years. Monitoring and

evaluation of technical assistance (TA) and institutional capacity building should receive

careful attention in Fund surveillance, and will be facilitated by the ongoing efforts to

strengthen the Fund’s monitoring and evaluation frameworks for CD activities.

67. Absorption capacity and resource availability will be constraining factors. Officials in

small states have over-burdened agendas, and finding time for capacity development, including TA

and training, is difficult. Other sources of risk to the effective implementation and sustainability of

capacity development outcomes are from shifts in political priorities, lack of resources in some small

developing states to absorb CD due to high staff turnover and shortages in certain skills. Given

these considerations, it is important to make the most of available capacity building resources

(Table 2). 55

Table 2. Fund TA to Small States, FY2015–16

68. A few guiding principles are relevant in considering capacity development approaches:

• Capacity development through TA and training needs to be tailored to each country’s needs and

absorption capacity.

• Capacity development needs to be informed and guided by surveillance and possibly provided at

the regional level given commonalities found among regional small states. Capacity development

ambitions need to be realistic, with capacity supplementation temporarily unavoidable in some

instances before capacity building can be effective. Where national solutions are not workable, it

may be necessary to explore regional or other “outsourced” solution—for example, reserve or

55 Small states receive significantly more capacity development through TA and training than larger peers when

scaled by population.

FY2015 FY2016 FY2015 FY2016 FY2015 FY2016

Caribbean 12.7 16.3 625.3 765.3 812.0 783.0

Asia-Pacific 8.8 8.8 651.0 521.6 597.0 456.0

Other Regions 8.7 8.1 341.4 494.7 252.0 353.0

Small States Total 30.2 33.2 1617.7 1781.6 1661.0 1592.0

IMF Total 287.6 302.5 14423.3 19518.2 11369.0 14457.0

SS in percent of IMF total 10.5 11.0 11.2 9.1 14.6 11.0

Technical Assistance Training Training

(Person Years of Field Delivery) (Participant Weeks) (Number of Participants)



debt management might be delegated to regional financial institutions—given both economies

of scale and the strong commonalities found among regional small states.

• Developing implementation capacity is critical. Resident or peripatetic regional macroeconomic

advisors may be useful in developing hands-on skills, particularly at an early stage, when

efficient communication and coordination with the authorities are crucial to kick-start capacity

building. Monitoring implementation of TA recommendations and evaluation of capacity

development are similarly important. The latter will be facilitated by the ongoing efforts to

strengthen the results-oriented approach through the implementation of the new results-based

management and the common evaluation frameworks for all Fund CD activities.56

• The regional TA centers (RTACs) are critical in providing support to small states. CARTAC in the

Caribbean and PFTAC in the Asia-Pacific region are particularly important in this context. A

regional approach has the advantage of offering opportunities for peer-to-peer learning

through workshops, seminars, attachments, and internships, while maintaining a focus on the

specific needs of the region. Regional capacity development is supported by development

partners who finance much of the RTAC budget, either in general terms or through dedicated

support for specific programs (e.g., Japan’s support for the improvement of external sector

statistics in the Asia and Pacific Region). South-South cooperation can be supported by drawing

on regional experts to deliver TA programs.

69. Other approaches can also be considered to help strengthen small states’

macroeconomic capacities:

• Staff exchanges. Staff expertise in small states and associated regional organizations could be

fostered through staffing exchanges. The options for economists from small states to join the

Fund for a limited period as special appointees could be expanded. Similarly, options could be

explored for Fund staff to take secondments to work with regional small states institutions as

well as resident or regional Capacity Development advisors in RTACs or beneficiary countries.

• Fund coordination. There may be scope for Fund staff to play a more active role in coordinating

the involvement of other development partners in the macroeconomic sphere. This should be

consistent, however, with the Fund’s macroeconomic focus, and should not crowd out core

activities.

COORDINATION WITH DEVELOPMENT PARTNERS

70. Support for small states will need to involve other international institutions and

development partners. The Fund will typically need to work alongside financial and non-financial

56 See 2018 Quinquennial Review of the Fund’s Capacity Development Strategy—Concept Note (IMF, 2017g).

http://www.imf.org/~/media/.../pp2018-review-of-the-funds-cd-strategy-concept-note.ashx



assistance programs managed by other development partners, in particular the World Bank and the

United Nations. In this area, good practices have included paying more attention to the following:

• Inter-agency cooperation should reflect the Fund’s comparative advantage and the relative

expertise of our counterparts. Close collaboration between the Fund and other development

partners should aim at establishing areas of comparative advantage and ensuring consistency in

policy advice.

• Country teams could find it helpful to draw on World Bank expertise and projects in several

macro-critical areas, such as labor market competitiveness, innovative financing (including debt-

for-nature), energy, and improving economic linkages with the tourism sector.57

• Close collaboration with other institutions would be particularly useful in identifying solutions to

regional challenges. The Fund and other partners could also pursue regional approaches to

overcome size related challenges, for example, by promoting trans-border financial sector

development within a region.

• Staff can involve other IFIs to provide staffing in Fund missions where external expertise would

complement the work of the Fund.

• Staff can discuss the timing of aid flows to reduce unnecessary volatility. Without changing the

total amount of foreign aid, a reallocation of these aid flows across time has the potential to

reduce spending volatility.

• Joint missions may provide benefits with each institution taking a lead role in the area where it

has the most expertise. While the Fund is not the central institution for addressing determinants

of long-run growth, it can still play a lead role in collaboration among IFIs in their engagement

with small states. Even where others take the lead, stepped-up collaboration can help enrich the

Fund’s policy advice and program design.

71. Collaboration on capacity building. The Fund can, and should, remain closely engaged

with the country’s development partners to help countries design and implement a well-coordinated

set of policies and to coordinate responses to TA needs. Where useful, and where requested by the

member, staff could produce periodic reports on macroeconomic developments and policies and

quarterly and annual reports of RTACs—in particular PFTAC and CARTAC—on capacity building

efforts for the benefit of the international community.

72. Fund staff should also be cognizant of other IFIs constraints in engaging with small

states. The World Bank’s work program in small states with relatively higher income per capita is

very small, so, while it is useful to draw on the Bank’s sectoral expertise, Fund staff will likely need to

bridge the gap by formulating advice to small states.

57 World Bank Group Engagement with Small States: Taking Stock, (WB, 2016).



Annex Table 1. List of Small and Micro Developing States 1/

Note:

1/ For the purpose of this Guidance Note, Small States are defined as developing countries that are Fund members with populations

below 1.5 million while micros states are a sub-group with populations below 200,000 as of 2011.

2/ Based on the IMF definition of a) a harmonized average CPIA country rating of 3.2 or less, or b) the presence of a UN and/or regional

peace-keeping or peace-building mission within the country during the past three years. Djibouti was dropped in the FY16 list after

department discussion.

3/ High-income countries (High) had per capita annual incomes of $12,476 or more in 2015; upper middle-income countries (UM) had

income levels of between $4,036 and $12,475; lower middle-income countries (LM) had income levels between $1,026 and $4,035; low-

income countries (Low) had income levels of $1025 or less, based on the World Bank Atlas method.

Country Micro States Fragile Situation 2 Island State Income Group 3 PRGT Eligibility

Antigua & Barbuda Y Y High

Bahamas, The Y High

Barbados Y High

St. Kitts and Nevis Y Y High

Trinidad & Tobago Y High

Belize UM

Dominica Y Y UM Y

Grenada Y Y UM Y

Guyana UM Y

St. Lucia Y Y UM Y

St. Vincent and the Grenadines Y Y UM Y

Suriname UM

Country Micro States Fragile Situation Island State Income Group PRGT Eligibility

Nauru Y Y High

Fiji Y UM

Maldives Y UM Y

Marshall Islands, Rep. Y Y Y UM Y

Palau Y Y UM

Tuvalu Y Y Y UM Y

Bhutan LM Y

Kiribati Y Y Y LM Y

Micronesia Y Y Y LM Y

Samoa Y Y LM Y

Solomon Islands Y Y LM Y

Timor Leste Y LM Y

Tonga Y Y LM Y

Vanuatu Y LM Y

Country Micro States Fragile Situation Island State Income Group PRGT Eligibility

Seychelles Y Y High

Cabo Verde Y LM Y

Djibouti LM Y

Mauritius Y UM

Montenegro UM

São Tomé and Príncipe Y Y Y LM Y

Swaziland LM

Comoros Y Y Low Y

Caribbean

Asia-Pacific

Other Regions

Annex Table 2. United Nations and World Bank: Groupings of Small Developing States

(By region)

Note: Countries marked in both bold and red are not included in the Fund listing of Small Developing States.

World Bank (50 Small States)

Africa (13) East Asia Pacific (13) Latin America and the Caribbean (13) Middle East and North Africa (3) Europe and Central Asia (6) South Asia Region (2)

Botswana Brunei Darussalam Antigua and Barbuda Bahrain Cyprus Bhutan

Cabo Verde Fiji The Bahamas Djibouti Estonia Maldives

Comoros Kiribati Barbados Qatar Iceland

Equatorial Guinea Marshall Islands Belize Malta

Gabon Micronesia Dominica Montenegro

The Gambia Nauru Grenada San Marino

Guinea-Bissau Palau Guyana

Lesotho Samoa Jamaica

Mauritius Solomon Islands St. Kitts and Nevis

Namibia Timor-Leste St. Lucia

Sao Tomé and Principe Tonga St. Vincent and Grenadines

Seychelles Tuvalu Suriname

Swaziland Vanuatu Trinidad and Tobago

United Nations (38 Small Island Developing States)

Caribbean (16) Pacific (13) Other (9)

Antigua and Barbuda Fiji Bahrain

Bahamas Kiribati Cabo Verde

Barbados Marshall Islands Comoros

Belize Micronesia Guinea-Bissau

Cuba Nauru Maldives

Dominica Palau Mauritius

Dominican Republic Papua New Guinea São Tomé and Príncipe

Grenada Samoa Seychelles

Guyana Solomon Islands Singapore

Haiti Timor-Leste

Jamaica Tonga

St. Kitts and Nevis Tuvalu

St. Lucia Vanuatu

St. Vincent and Grenadines

Suriname

Trinidad and Tobago

STA

FF G

UID

AN

CE N

OTE O

N T

HE F

UN

D’S

EN

GA

GEM

EN

T W

ITH

SM

ALL D

EV

ELO

PIN

G S

TA

TES

INTER

NA

TIO

NA

L MO

NETA

RY F

UN

D 3

9

Annex Table 3. List of Small States with Staff-Monitored Programs

(As of March 31, 2017)

Note: SMPs are sent to the Board for information not discussion.

Country Approval Date Original Current Original Length Extension Subsequent

Expiration Date Expiration Date (in months) (in months) Program

São Tomé and Príncipe

1-Jan-02 30-Jun-02 31-Dec-02 6 6 PRGF in 2005

Comoros 1-Jan-05 31-Dec-05 31-Dec-06 12 12EPCA in 2008

ECF in 2009

Djibouti 1-Jul-05 31-Dec-05 31-Dec-05 6 0 PRGF in 2008

Swaziland 4-Apr-11 3-Oct-11 Off-track 6

Comoros 1-Oct-16 31-Mar-17 31-Mar-17 6 0

STA

FF G

UID

AN

CE N

OTE O

N T

HE F

UN

D’S

EN

GA

GEM

EN

T W

ITH

SM

ALL D

EV

ELO

PIN

G S

TA

TES

40

IN

TER

NA

TIO

NA

L MO

NETA

RY F

UN

D

Annex Table 4. Fund Emergency Assistance in Small States

(2003–2016)

Note: The Rapid Financing Instrument has replaced the IMF’s previous emergency assistance policy that covered Emergency Natural Disaster Assistance and Emergency Post-

Conflict Assistance.

1/ Reflects the fourteenth quota review of February 29, 2016.

Country Approval Date In millions of

SDRs

In percent of

Quota 1/

Type Event

Exogenous Shocks Facility (ESF) and Rapid Credit Facility (RCF)

Comoros 12/15/08 2.2 25 ESF-RAC Impact of higher fuel and food prices

St. Vincent and The Grenadines 5/15/09 3.7 45 ESF-RAC Global economic slowdown effect on tourism and FDI

Dominica 7/10/09 3.3 40 ESF-RAC Hurricane & Global economic slowdown effect on tourism and FDI

St. Lucia 7/27/09 6.9 45 ESF-RAC Global economic slowdown; tourism decline

Maldives 12/4/09 8.2 100 ESF-HAC Global economic slowdown

Samoa 12/7/09 5.8 35.8 ESF-RAC Earthquake & Tsunami

St. Lucia 1/12/11 3.8 25 RCF Hurricane Tomas

St. Vincent and The Grenadines 2/28/11 2.1 17.7 RCF Hurricane

St. Vincent and The Grenadines 7/25/11 1.2 10.6 RCF Torrential Rains and Floods

Dominica 1/11/12 2.1 17.8 RCF Torrential Rains and Floods

Samoa 5/15/13 5.8 35.8 RCF Cyclone Evan

St. Vincent and The Grenadines 8/1/14 4.2 35.5 RCF / RFI blend Floods

Vanuatu 6/5/15 17.0 71.4 RCF / RFI blend Cyclone Pam

Dominica 10/28/15 6.2 53.5 RCF Tropical Storm Erika

Emergency Natural Disaster Assistance

Grenada 1/27/03 2.9 17.9 ENDA Hurricane

Grenada 11/15/04 2.9 17.8 ENDA Hurricane

Maldives 3/4/05 4.1 19.3 ENDA Tsunami

Dominica 2/4/08 2.1 17.8 ENDA Hurricane

Belize 2/18/09 4.7 17.6 ENDA Hurricane

St. Kitts and Nevis 5/15/09 2.2 17.8 ENDA Hurricane

St. Lucia 1/12/11 1.5 10 ENDA Hurricane

Emergency Post-Conflict Assistance

Comoros 12/15/08 1.1 13 EPCA Conflict

STA

FF G

UID

AN

CE N

OTE O

N T

HE F

UN

D’S

EN

GA

GEM

EN

T W

ITH

SM

ALL D

EV

ELO

PIN

G S

TA

TES

INTER

NA

TIO

NA

L MO

NETA

RY F

UN

D 4

1

4

2

Annex Table 5. Fund Financing Arrangements for Small States

(2003–2016)

Source: Monitoring of Fund Arrangements (MONA) Database.

http://www.imf.org/external/np/pdr/mona/index.aspx.

1/ Includes augmentation.

42

IN

TER

NA

TIO

NA

L MO

NETA

RY F

UN

D

STA

FF G

UID

AN

CE N

OTE O

N T

HE F

UN

D’S

EN

GA

GEM

EN

T W

ITH

SM

ALL D

EV

ELO

PIN

G S

TA

TES

Country Arr. Type Year

Original

Duration

(in months)

Actual

Duration

(in months)

Total Amount

Approved

(in SDR mn)

Actual Approved Amount

(% of quota at approval)

Dominica PRGF 2003 36 36 8 94

São Tomé and Príncipe PRGF 2005 36 36 3 40

Grenada PRGF 2006 36 48 16 140

Djibouti 1/ ECF 2008 36 44 22 140

Seychelles SBA 2008 24 13 18 200

São Tomé and Príncipe ECF 2009 36 36 3 35

Comoros ECF 2009 36 51 14 153

Maldives SBA 2009 36 36 49 600

Seychelles EFF 2009 36 48 26 300

Grenada ECF 2010 36 36 9 75

Solomon Islands SCF 2010 18 18 12 120

Antigua and Barbuda SBA 2010 36 36 68 500

St. Kitts and Nevis SBA 2011 36 36 53 590

Solomon Islands SCF 2011 12 12 5 50


Solomon Islands ECF 2012 36 40 1 10

Seychelles EFF 2014 36 36 11 105

Grenada ECF 2014 36 35 14 120


Suriname SBA 2016 24 11 342 265

http://www.imf.org/external/np/pdr/mona/index.aspx

Annex Table 6. Selected Recent Examples of Sovereign Debt Restructurings in Small States

Country Start Date of

Restructuring

NPV Reduction Participation Rate

External Domestic Principal Haircut Interest Haircut

Dominica 2003 50 percent 78.5 percent yes yes yes yes

Mandatory debt-management

provision in the bond

exchange.

Yes

Grenada 2005 40–45 percent 90 percent (commercial) yes yes no yesRestructured debt that had

government guarantees.No

Belize 2006 21 percent100 percent (bond exchange);

98 percent of eligible debtyes no no yes

First country since the 1930s to

use collective action clause in

a bond issued under the New

York Law.

No

Seychelles 2009 75 percent100 percent (bond exchange);

98 percent of eligible debtyes no yes yes

First time a partial guarantee

from a multilateral

organization (African

Development Bank) was

offered in the context of a

sovereign restructuring.

Yes

St. Kitts and Nevis 2012 Above 50 percent100 percent (external

commercial debt and bonds)yes yes yes yes

Partial guarantee from the

Caribben Development Bank

on the new debt instruments ;

Creation of a Banking Sector

Reserve Fund to maintain

banking sector stability during

the restructuring; Creation of a

Special Purpose Vehicle for

debt secured by land.

Yes

Interesting Features of the

Restructuring

IMF Arrangement at the

Time of Restructuring

Source: Jahan, S. (2013)," Experiences with Sovereign Debt Restructuring: Case Studies from the OECS/ECCU and Beyond", in Alfred Schipke et al edited The Eastern Caribbean Economic and Currency Union: Macroeconomics

and Financial Systems , International Monetary Fund, Washington D.C.

Type of Debt Restructured Treatment

INTER

NA

TIO

NA

L MO

NETA

RY F

UN

D 4

3

STA

FF G

UID

AN

CE N

OTE O

N T

HE F

UN

D’S

EN

GA

GEM

EN

T W

ITH

SM

ALL D

EV

ELO

PIN

G S

TA

TES



Appendix Box 1. Monetary Policy in Small States 1/

Particular challenges for the implementation of monetary policy exist in small states, as discussed below.

Fund research has identified several important preconditions for effective implementation of

monetary policy based on inflation targeting or monetary targeting. Many small states have stable

macroeconomic environments and sound fiscal policy, but some features common to small states mean

other preconditions are frequently not met. 2/

Shallow and non-competitive financial markets, often dominated by large (in some cases foreign)

banks, raise spreads between lending and deposit rates, impeding interest rate pass-through.

Poorly functioning or absent interbank markets increase demand for precautionary holdings of central

bank reserves and this may impede monetary policy transmission.

Poorly developed government securities markets reduce the scope of potential open market

operations.

Limited technical capacity complicates adequately overseeing financial institutions and engaging in

complex central bank operations. Central bank autonomy may also be an issue in small and interconnected

political systems.

The exchange rate is thus a common anchor for small states. In addition to the above factors, the high

share of foreign trade in GDP and, in many cases, dependence on a single important trading partner,

support the case for exchange rate-based monetary policy. This can range from a heavily managed

exchange rate, to a peg, currency board, or full dollarization.

A strong international reserves position and prudent fiscal policy can strengthen such regimes.

Exchange rate anchors are more credible when central banks have sufficient international reserves to cope

with potential adverse exogenous shocks. Prudent fiscal policies are also key, but this can be complicated

in small states by highly volatile, unpredictable, or lumpy fiscal revenues, and where limited options for

financing public deficits further constrain fiscal policy. Strong oversight of financial sector risks, particularly

in countries with extensive offshore financial linkages, are also important, but here, too, limited capacity

may be an issue.

Supervisors and regulators should also be aware of other potential issues. The scope for pursuing

greater competition is limited by the extent of the market, which often leads to high spreads between

lending and deposit rates. Small size also reduces prospects for capital market development, including

equity and bond markets, but also hedging instruments and other risk management tools. Finally, risk

diversification is problematic in economies with few potential borrowers, tightly interlinked economies, and

little geographical or economic diversification. Despite these constraints, limiting interest rate spreads may

not produce the anticipated outcome because this can be easily circumvented by higher fees or

commissions, and could result in banks not extending credit to willing borrowers. Instead, the

recommendation should be in favor of greater transparency about interest rate and lending policy (for

instance, requiring banks to publish rates) and ensuring that underwriting standards are robust.

____________________________________

1/ Prepared by C. Visconti and J. Walsh.

2/ See for instance, Monetary Policy Implementation at Different Stages of Market Development (IMF Occasional Paper 244) and

Monetary Policy Transmission Mechanisms in Pacific Island Countries (IMF WP/11/96).

http://www.imf.org/external/np/mfd/2004/eng/102604.htm

http://www.imf.org/external/pubs/ft/wp/2011/wp1196.pdf



Appendix Box 2. Fiscal Rules for Small States 1/

Fiscal rules can help avoid excessive budget deficits and public debt accumulation. However, challenges for the design

and operation of fiscal rules are particularly acute for small states, and few have adopted such rules to date. This

appendix provides guidance on approaches that could be tailored to small states’ needs.

Conceptual overview. Excessive budget deficits and procyclical fiscal policies are often thought to reflect

distorted policymakers’ incentives (e.g., as a result of myopia—Alesina and Tabellini, 1990), or ineffective

coordination of competing demands on government resources (the “common pool” problem—von Hagen and

Harden, 1995). While procedural rules mitigate the common pool problem, policymakers have often tried to

promote fiscal soundness through fiscal policy rules. 2/ These put a durable constraint on fiscal policy by

combining numerical limits on key indicators—most often the deficit, the public debt or both—with provisions

making deviations from the limits costly for policymakers. Empirically, well-designed fiscal rules are associated with

better fiscal performance (e.g., Debrun and others, 2008).

Regardless of country characteristics, effective fiscal rules generally satisfy one pre-requisite and four conditions:

Prerequisite. Because a fiscal rule is meant to constrain budget preparation and execution, public financial

management (PFM) systems should be strong enough to ensure that the budget closely reflects policymakers’

plans, and effectively guides their actions. Priorities include a top-down approach to budgeting, solid revenue

forecasting, and a medium-term framework.

Relevant objective. An effective fiscal rule should be well connected to the problem it is expected to address. The

primary objective of most fiscal rules is to preserve debt sustainability.

Simplicity and transparency. Complicated rules include those with multiple and potentially inconsistent

numerical targets, broad exemptions and exclusions, and narrow coverage of the public sector (e.g., applying only

to a small part of the government or selected expenditure ceilings not connected to debt sustainability). Such rules

are harder to monitor and more easily circumvented.

Resilience in the face of shocks. The rule should allow the budget to buffer adverse exogenous shocks, including

the accommodation of cyclical fluctuations in revenues and unforeseeable emergencies. Rules that too often

mandate undesirable or politically/socially unfeasible policies are unlikely to be sustained.

Enforceability. Deviations from the rule should entail tangible costs for the government. If the numerical limit

only applies ex ante, this could mean the prohibition for the Executive to submit to the Legislature a budget

inconsistent with the rule. If the limit also applies ex post, this could imply tighter restrictions on future budgets—

“debt brakes” 3/—or direct sanctions for policymakers (beyond reputational effects).

At a generic level, the Fund’s advice on fiscal rules reflects the central trade-off between credibility and

flexibility. While credibility calls for strict limits on discretion with clear costs in case of deviation, flexibility is

needed to ensure the resilience of the rule in the face of changing circumstances. Setting a limit on the general

government structural deficit with well-defined escape clauses and some form of enforcement mechanism is the

most common expression of the Fund’s advice.

That said, the details of an effective fiscal rule are country-specific, as they depend on the nature of the bias

embedded in unconstrained policies, the sensitivity of the budget to exogenous shocks, and the characteristics of

the political system. In some cases, the risk of side effects might also need to be pre-empted. For instance, a fiscal

rule could encourage short-term expedients, such as deferred spending (an example would be underinvestment)

or cuts in high-quality discretionary outlays.

_______________________________

1/ Prepared by Xavier Debrun.

2/ See Kopits and Symansky (1998) and IMF (2009).

3/ A “debt brake” is an automatic correction mechanism mandating offsets for past deviations. It is often advised when judiciary

enforcement or automatic sanctions lack credibility, which is the case in most political systems.



Appendix Box 2. Fiscal Rules for Small States (concluded)

Designing fiscal rules for small states is challenging because the terms of the credibility-flexibility trade-off

are particularly unfavorable. On the one hand, expenditure pressures are often acute, calling for very strict rules.

Pressures range from a strong demand for insurance against shocks (including through off-budget instruments

such as Public Private Partnerships (PPPs) and guarantees), the expectation for the government sector to be the

last-resort source of growth and job creation, and high production costs for public goods and services. Pressures

for sweeping tax exemptions aimed at attracting businesses only add to the problem. On the other hand, large

volatility calls for very flexible arrangements. As discussed in the main text, the state budget often the insurer of

last-resort because alternative insurance mechanisms are ineffective (monetary policy is constrained by fixed

exchange rates or dollarization, the domestic financial sector is shallow and outward oriented, and access to

international capital markets is limited).

Not surprisingly in light of this difficult trade-off, fiscal rules are few among small states. To date, only Cabo

Verde, Mauritius, Suriname, and most recently the Maldives operate fiscal policy rules at the national level. 4/

However, in the first two cases, the rule is a ceiling on the public debt to GDP ratio, which as elsewhere, has proved

too inflexible to be credibly enforced. By contrast, in the Maldives, a cap on the overall deficit (3.5 percent of GDP)

will bind from 2016 onwards. It is combined with a debt ceiling to be set for five years by the Minister of Finance,

starting from 60 percent of GDP in 2016. An explicit debt path places a useful check on a budget balance rule

because the long-run debt level implied by a given deficit depends on highly uncertain assumptions about long-

term GDP growth and borrowing costs. Explicit escape clauses are a welcome feature of the fiscal rule in the

Maldives and Mauritius. 5/

The design of fiscal rules may have to deviate significantly from the Fund’s advice for larger economies.

Small states’ acute common pool problem makes strengthening PFM systems a top priority. Once the budget itself

can be deemed credible, then a numerical fiscal rule is worth considering, tailored to the specifics of the country.

Country teams should keep in mind the following considerations:

Formulating the rule in terms of headline budget balance may be the only option. Small states typically have

no well-defined economic cycle, hence no clear definition of the structural balance. 6/ Debt ceilings alone are

unlikely to be credible, especially after very large shocks.

In “normal times”, consider a budget balance floor that is close-to-balance or in surplus and binding only

ex ante. High volatility calls for large buffers. In normal circumstances, debt should decline. Unexpected shocks

during the year should be accommodated to the extent that financing is available.

Set a “debt brake.” Large ex post deviations from the headline balance floor should switch the rules-based

system from “normal times” to “adjustment mode” that sets a reasonable adjustment path.

Carefully designed escape clauses are a must. These should not only accommodate significant shocks, but also high-

quality policy initiatives, such as sizable investment projects with a clear return.

Ensure a broad coverage, possibly beyond the general government. Given the intense expenditure pressures, the rule

should not result in outsourcing fiscal policy to off-budget entities or lead to large contingent liabilities, such as PPPs or

private debt guarantees.

Be open to expenditure ceilings on specific categories. Although generally not advised, ceilings on certain

expenditure categories particularly subject to pressure (e.g., subsidies, wage bill) might be considered in small states. The

reason is that a high-level rule might lead to severe distortions in terms of expenditure composition (crowing out of

priority spending by “incompressible” items).

_________________________________________

4/ ECCU member states are also subject to regional benchmarks on their public debt.

5/ In Mauritius, the debt ceiling can be exceeded in case of “emergency” or for the purpose of financing large investment

projects. In the Maldives, the rule makes an exception for natural disasters (imposing hardship on at least 15 percent of the

population) and “economic downturns,” although the magnitude of the latter remains unspecified.

6/ Additional complexities arise in the case of a resource-rich economy.

http://www.imf.org/en/Publications/Policy-Papers/Issues/2016/12/31/Macroeconomic-Policy-Frameworks-for-Resource-Rich-Developing-Countries-PP4698



Appendix Box 3. The Caribbean Catastrophe Risk Insurance Facility (CCRIF) 1/

Sovereign insurance against natural disasters is a new option for some small states, as discussed below.

The Caribbean is one of the most disaster-prone regions

of the world with 6 countries in the top 10 and all of them

in the top 50 hot spots. Over the last 60 years, the region

has suffered from 187 natural disasters mostly hurricanes.

Losses from natural disasters averaged about 1 percent of

GDP per year since 1960. Following the severe devastation

caused by hurricanes in the Caribbean in 2004, the CARICOM

Heads of Government requested World Bank assistance in

improving access to catastrophe insurance.

The CCRIF, established in May 2007, is the first multi-

country risk pool in the world. 2/ The CCRIF is a regional

insurance fund that allows Caribbean governments to

purchase insurance coverage to finance immediate post-

disaster recovery needs. The CCRIF currently includes 16

Caribbean, of which 13 are classified as small and micro states.

It is the result of collaboration between the region’s

governments and key development partners. It was capitalized through contributions to a multi-donor Trust Fund by the

Government of Canada, the European Union, the World Bank, the governments of the UK and France, the Caribbean

Development Bank and the governments of Ireland and Bermuda, as well as through membership fees paid by participating

governments.

Insurance policies are triggered and payouts calculated using a parametric catastrophe risk model (the multi-risk peril

estimation system—MPRES) calibrated specifically for the Caribbean. Losses are based on characteristics of a natural hazard

event (provided by independent sources) and impacts of the hazard on pre-defined national exposure. This allows the CCRIF to

provide quick claims settlement to a participating government affected by an earthquake or hurricane. Payouts are contingent

on pre-established trigger events measured in terms of wind speed or ground acceleration and proportional to the estimated

loss derived from the hazard impact model.

The CCRIF Functions as a pooled reserve controlled by participating governments. It retains risk from participating

governments through its own reserves, and transfers risks that exceed its own capacity to reinsurance markets. The leveraging of

its own reserve pool to purchase additional risk financing capacity directly in the reinsurance market allows the CCRIF to secure

sufficient financial capacity to finance major losses. This structure also provides participating governments with insurance

coverage at about half the price they would face if they approached the reinsurance industry independently. Insurance coverage

under the CCRIF is typically capped at 20 percent of total estimated losses, a proportion which is believed to be sufficient to

cover a government’s immediate liquidity needs to begin emergency operations after an adverse event until other financial

resources are mobilized.

The CCRIF covers middle-level weather-related risks, (10–20 year events) and facilitates risk transfer and risk

diversification for small vulnerable economies. It allows these countries to access international private insurance markets at a

fraction of the cost they would face individually. Still, countries under-insure as catastrophe premiums are high. The parametric

model allows payouts to be made very quickly usually within 14 days providing liquidity at a time when government budgets are

under stress. However, because it is focused on midrange risks more frequent events like flooding which can cause significant

financial loss are not covered. To address this, the CCRIF introduced its excessive rainfall product in June 2013 to provide flood

coverage.

_________________________________

1/ Prepared by Wendell Samuel.

2/ The member countries of the CCRIF are, Anguilla, Antigua and Barbuda, Bahamas, Barbados, Belize, Bermuda, Cayman Islands,

Dominica, Grenada, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Trinidad and Tobago and the

Turks and Caicos Islands.

4.7

7.6

8.9

8.9

10.2

10.2

12.7

15.1

15.1

17.2

17.2

20.2

23.6

0 5 10 15 20 25

Montserrat

Anguilla

Grenada

Trinidad and Tobago

Barbados

St. Kitts and Nevis

St. Vincent

Antigua and Barbuda

Dominica

Belize

St. Lucia

Bahamas

Jamaica

Probability of a Hurricane Striking on a Given Year (In percent)

Source: IMF, Caribbean Small States: Challenges of High Debt, 2013.

AND LOW GROWTH2.



Appendix Box 4. Risk Financing Toolkit

Financing needs could be segmented by date, distinguishing urgent financing needs (under three months), short

term needs (under one year), and medium term needs (over one year). This would help to identify the necessary

scale of fiscal buffers, access to financing, and/or risk transfer arrangements. This appendix explores the different

elements of the disaster risk financing tool kit in more detail.

Domestic financing and deposit buffers. Government deposits and access to domestic bank financing provide

buffers for shocks, but have financial sector liquidity implications that need to be managed. They are best suited

for less costly disasters.

• Central and commercial bank financing may provide a limited buffer against shocks. Central bank

financing of the budget should be strictly limited on account of risks of fiscal dominance that could

undermine monetary policy effectiveness. Scope to borrow from domestic commercial banks is also likely to

be limited, as liquidity in the system may not be adequate to provide additional fiscal financing at a time

when the banking system faces other financing and liquidity needs due to the disaster. Overall, domestic

borrowing is likely to be most useful in the context of small-scale disasters.

• Government deposit buffers provide an alternative to domestic borrowing. In principle, such buffers

are designed to cover early disaster response needs without compressing other priority spending until other

sources can be mobilized. In some disaster-vulnerable countries in the Pacific, governments aim to maintain

a deposit buffer equivalent to three months of recurrent spending. This buffer could be in the form of

deposits in the government’s general fund, a “virtual” contingency fund within the general fund, or a

dedicated fund for natural disasters.

Sources of Post-Disaster Fiscal and BOP Financing

Large Disasters

Middle-range

Disasters Small Disasters

Disaster scale (more than 35

percent of GDP)

(2 to 35 percent

of GDP)

(1 percent of

GDP or less)

Sources of financing: 1/

Reserve drawdown No No No

Domestic bank financing No Yes No

External grant financing Yes Yes No

External loan financing Yes Yes No

Remittances Yes No No

Adequacy of BoP financing to cover losses

Number of disaster events 8 8 8

Average losses (percent of GDP) 48 3 0.6

Additional ext. financing (percent of GDP) 2/ 22 4.5 -1.8

Sources: IMF and EM-DAT data.

1/ Balance of payments data provided information on reserve drawdown and remittances; fiscal data provided information

on domestic bank financing; and fiscal and BOP data provided information on external grant and loan financing.

2/ Cumulative change in annual average financing for disaster year and three following years compared to the annual

average financing three years prior to the disaster. The over-financing of middle-range disasters is due to one outlier

(Seychelles).



Appendix Box 4. Risk Financing Toolkit (concluded)

External borrowing and insurance. Contingent lines of credit help reduce ex ante disaster financing uncertainty, while

insurance products allow for risk transfer, at a cost.

• Contingent lines of credit reduce external financing uncertainties. Contingent financing arrangements can be

arranged with bilateral, multilateral, and commercial creditors. At a bilateral level, for example, the Marshall Islands,

Micronesia, and Palau benefit from compact agreements with the United States offering access to emergency

support from relevant U.S. agencies. 1/ At the multilateral level, the World Bank’s CAT DDO offers a pre-approved

line of credit for countries experiencing disasters. Currently, this instrument is available only for middle income

countries, and the Seychelles is the only small state that has negotiated coverage. 2/ The World Bank, with G20

financing, also recently established a Pandemic Emergency Financing Facility which could serve as a good model for

natural disaster financing. The facility protects poor countries against pandemics using catastrophe bonds,

reinsurance, and a cash window. Financing under the IMF’s RCF and RFI are not fully contingent, in that they are

subject to conditions for access; 3/ however, the fact that these do not entail a Fund-supported program helps

facilitate rapid disbursement. One downside to contingent credit is that the ex ante fiscal costs of disaster relief

remain uncertain and, even on an ex post basis, the fiscal impact is deferred until debt service falls due.

• More clarity in budgeting can be provided through insurance and other risk transfer arrangements. By

insuring public assets, governments can reduce uncertainties associated with direct exposure to disaster risks.

Similarly, encouraging insurance of private property reduces the risk that the public sector will be called on to cover

private losses. Prompt insurance compensation reduces downtime for productive assets, reduces disruption of

infrastructure, and indemnifies producers for income losses.

• Traditional indemnity insurance of physical assets is not widespread in small states. The cost of indemnity

insurance is high, especially where markets are underdeveloped and competition is limited. High premiums can also

reflect the high probability and cost of disasters in small states. As a result, uptake is low, with premium payments

for non-life cover averaging just 1 percent of GDP for typical small states. That said, Belize and Grenada rely on

traditional insurance against severe natural disasters. There is some evidence from developing countries that

traditional insurance for disasters has been more successful and sustainable under public-private partnerships than

under exclusively private or public options. In considering this option, contingent risks to the budget would need to

be carefully monitored and the private market would need better regulation and supervision with some level of

mandatory catastrophe insurance.

• Innovative approaches for sharing natural disaster risks have emerged over the past decade. Parametric

insurance has emerged as a complement to regular indemnity insurance. It is effectively an options contract that

pays out in the event of a disaster that exceeds a pre-specified severity. Triggers for payout can be specified, for

example, in terms of storm, flood, or earthquake intensity. Parametric insurance is quick-disbursing, but costs can be

high because the market for cover is still developing. In some cases, economies of scale have been achieved by

pooling cover at a regional level. A second innovation has been the development of catastrophe (CAT) bonds, which

are issued as financing instruments by disaster-vulnerable countries. In exchange for a generous coupon payment,

investors agree to forgive the bond principal in the event of a disaster (as measured by a parametric trigger). This

releases resources from debt service to finance disaster response.

______________________________________

1/ In February 2016, the government of the Marshall Islands declared a state of emergency, citing severe drought conditions,

resulting from a protracted El Niño system. A subsequent declaration of emergency by the U.S. administration activated support

from FEMA.

2/ Discussions are underway as part of the IDA 18 replenishment to make the CAT DDO available to IDA countries, including

small island states.

3/ For example, that the country faces an urgent balance of payments need, and that this is expected to be resolved within one

year and that no major policy adjustments are necessary to address underlying balance of payments difficulties.



Appendix Box 5. Devaluations in Small States: How Effective? 1/

Exchange rate devaluations in small states typically involve a larger inflation pass-through and smaller output response than

in larger states. However, devaluations can effectively support external adjustment, especially with appropriately supportive

structural policies, as discussed below.

Small states are often skeptical about the effectiveness of exchange rate adjustment for tackling currency

overvaluation. Small states often maintain fixed exchange rate regimes, and both internal and external devaluations entail

unpleasant macroeconomic effects, which differ from those in larger economies because of their high degree of trade

openness. To understand better whether external devaluations are effective in small states, the results of event and

econometric studies on devaluations in small states are discussed in this box. 2/ Our findings suggest that:

External devaluations can be effective in small states, providing a strong boost to growth and the external position.

After a decline in the year of the devaluation, growth picks up quickly in small states, driven largely by a very strong pickup

in investment and a robust export growth. While this is true on average, it does not happen in all cases: in fact, in about half

of the cases three-year average growth slows down in the medium term following devaluations. Such outcomes are not

unique to small states, however, the growth pick up as well as the mix of growth outcomes are actually no different from

the large states.

In small states, devaluations tend to operate more through the expenditure compression channel than through the

expenditure switching one. Due to the structure of the economy in small states: (i) exports respond less because of scale

limitations

and higher

share of

imported

inputs;

(ii) there is

less scope to

switch

expenditures

from imports

to domestic

import substitutes due to scale; and (iii) for the same nominal devaluation, the pass-through to inflation is significantly

higher in small states due to the larger import content of their consumption basket. As a result, consumption is affected

significantly by adverse income and wealth effects, especially in countries with large external current account deficits and

debts, reducing labor income and increasing poverty.

Supportive policies are critical to increasing the success probability of external devaluations in small states. In

particular: (i) it is important that tight wage policies are maintained after devaluation to ensure that the gains from the

nominal adjustment are not eroded; (ii) the devaluation and supporting policies should be credible enough to stem market

perceptions of any further devaluation, which can impose large economic costs; an important condition in this respect is

the sustainability of the fiscal position; (iii) structural reforms could help remove bottlenecks to investment, to allow its

strong growth post-devaluation and address some of the factors underlying weak competitiveness at the root; and

(iv) concerns about the undue compression in consumption can be addressed through appropriately targeted social safety

nets, including through the use of the net income redistribution from the private sector to the government that frequently

occur following depreciations.

______________________________________

1 Prepared by Geoffrey Keim, based on “Who is Afraid of External Devaluations? (and Should They Be?),” by Sebastian Acevedo, Aliona

Cebotari, Kevin Greenidge, Geoffrey Keim, Mico Mrkaic, and Stephen Snudden, IMF, forthcoming.

2 The event study conducted by staff considered 78 devaluation events over the past 30 years, of which 20 events in small states. The study

also uses an econometric approach and simulations using the Fund’s Global Integrated Fiscal and Monetary model, calibrated to the

characteristics of small states, which broadly reinforce the findings of the event study.

80

100

120

140

160

80

100

120

140

160

-4 -2 0 2 4 -3 -1 1 3 -4 -2 0 2 4 -3 -1 1 3 -4 -2 0 2 4 -3 -1 1 3

GDP Cons. Investment Govt Cons. Exports Imports

Small Countries

Large Countries

Small States: Real GDP Following Devaluations(averages of samples; indexes, t-1 = 100)

Sources: WEO and Fund staff estimates.



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